Weekly Bond Update: Is Portugal still a trade opportunity?
- Portugal is doing fairly well compared to some years ago
- Government debt is still at a risky level of 130% of GDP
- Rating upgrades are around the corner
- ECB policy normalisation is a risk factor for southern EU countries
- Greece may be the next investment opportunity to watch
Pre-crises, Portugal was rated Aa2/ AA- (Moody’s/S&P) but after, the country's rating quickly fell. It reached the bottom in 2013 with Ba3/BB. Portugal's economic conditions quickly deteriorated with the bankruptcy of Banco Privado Portugues and the nationalisation of Banco Portugues de Negocios. The country had been engaged in risky credit and public debt creation, putting its economy under stress. Finally, in 2011 Portugal had to request EUR 78bn from the IMF-EU as a bailout package since the country wasn’t able to finance itself though public and private debt. At that time unemployment reached 15%.
From AA- to BB and back?
Portugal is nowadays better off and Portuguese 10y yields plunged from approx. 15% in 2012 to an impressive 2.35% today. However, the country still has a public debt equal to 130% of its GDP and remains vulnerable to rising interest rates. Standard and Poor’s became the first of the big three credit rating agencies to put Portugal back to investment grade. If the country’s economy continues to improve, Moody or Fitch will seek to improve the country’s current rating too.
A second rating upgrade to IG would be an important event as it is a key requirement in order to integrate Portugal back into government bond indexes, thus allowing many institutional investors to enter in the Portuguese curve.
It is difficult to say whether investors coming in late the Portuguese curve will be able to push yields considerably downwards as the spread between Portugal and other EU countries is already at its lowest. However, trading the Portuguese spread against Italy may still provide interesting returns as Portugal yields may not go lower, but Italian bond yields may correct in the medium term.
ECB policy normalisation as a risk factor
As a matter of fact, even though the overall Eurozone economy is slowly improving, Italy remains a wild card. The country’s economy is struggling amid a high debt burden and the future is uncertain with the general election coming in May next year. Buying Portugal and selling Italy will allow investors to profit from a further modest downwards movement of Portuguese yields combined with a possible quicker widening of BTPS’s yield.
The risky part of such trade lies within the ECB policy normalisation agenda. As a matter of fact, should ECB president Mario Draghi proceed with his plans in January next year, hawkish economic trends would put at risk companies in the periphery as they would face a higher cost of funding and lack of revenue growth. This would put weak countries on the verge of recovery again under stress. The bad news is that the new monetary policy regime may be implemented in January, the same month that Portugal may be able to be integrated back into IG indices following another rating upgrade.
Source: Bloomberg
Perhaps the real investment opportunity at the moment doesn’t lie with Portugal at all as one may need to look beyond its rating upgrade. Greece is offering more than double the yield of Portugal with the 10-yr benchmark at 5.55%. According to Bloomberg, Portuguese bonds have returned 10.57% year-to-date yet they aren’t the best performer in the European space. Greece’s sovereigns have returned 16.73% in the same period. Greek fiscal performance this year is very strong and everything points to the fact that it will be able to successfully complete the bailout programme next year. The country was successful in attracting investors to a EUR 3 billion bond offering in July, which was Greece’s first bond issue since 2014 and now is looking to swap 20 small bond issues for five new ones in order to commence normal financing operations.
Greece is in Germany's interest
Yet, one may be put off by last Sunday’s German election. Merkel won her fourth term, but her support fell sharply. There is now growing anti-euro sentiment even in the heart of the EU. Germany has benefitted from loans and bonds purchased in support of Greece over nearly a decade and the country still holds big a big part of Greek debt. Therefore it should be in the government’s best interest to fully back a Greek recovery.
— Edited by Clemens Bomsdorf
Althea Spinozzi is a sales trader at Saxo Bank