Position: Long Germany (EWG)
This week is a big one for European bond issuance. Portugal, Spain, Italy, Netherlands, and Germany are preparing bond and bill sales worth as much as €42 billion ($54 billion) this week:
1. Today: The Netherlands issued €3.5 billion of debt.
2. Tomorrow: Portugal plans to borrow as much as €1.25 billion, repayable in October 2014 and June 2020. Germany seeks €7 billion.
3. Thursday: Spain will auction as much as €3 billion of five-year bonds. Italy will market securities maturing in 2026 and 2015.
Portugal continues to be one country among the periphery that is getting the most attention due to its sovereign debt fears. The yield on the 10YR government bond is hovering just under the 7% line. As we show in the chart below, the 7% level has been a critical gravitational line. A mere 17 days after Greece broke through it on May 15, 2010 it received a €110 Billion bailout; whereas Ireland broke the line on 10/29/10 and received a bailout of €85 Billion on 11/29.
The focus now turns to the reception of Portugal’s issuance of €1.25 Billion tomorrow. Hanging in the balance is the country’s need to borrow €20 billion in bonds this year to finance its budget deficit and redemptions.
International Support
Bullish statements today from Japanese Finance Minister Yoshihiko Nado that his nation will use foreign-exchange reserves to buy “more than 20 percent” of bonds to be issued under a special assistance program for Ireland appear to be reducing yields across the periphery, including Portugal, over the short term.
Further, Japan’s insurance follows remarks from Chinese Vice Commerce Minister Gao Hucheng on January 5th in Madrid that China will buy Spanish public debt in the primary and secondary markets and a statement by Chinese Vice Premier Wang Qishan on December 21th that China had taken “concrete action” to help Europe with its debt problems.
While over the immediate term TRADE (3 weeks or less) these international actions could buoy peripheral bond prices, on the intermediate term TREND and long term TAIL we do not expect they’ll make a dent in arresting the risk premium to own the region’s sovereign debt imbalances. As the chart above also presents, even the bailouts of Greece and Ireland failed to arrest the expedient rise in yields.
Portugal’s Weak Economic Outlook
Today Bank of Portugal announced that GDP will shrink -1.3% in 2011 and expand +0.6% in 2012. Back on October 7th the bank had forecast no GDP growth in 2011, however the estimates did not include the austerity measures announced by the government on September 29th.
Those budget deficit reduction measures included:
- Cutting public-sector wage by 5% for those earning more than €1,500/month
- Freezing public-sector hiring
- Raising VAT by 2% to 23%
With a budget deficit of 9.3% of GDP in 2009, the government has set a target of 4.6% for 2011, and aims to meet the EU deficit limit of 3% in 2012. However, the government’s 2011 deficit projection was based around a +0.2% GDP.
Portugal’s recessionary outlook (GDP has averaged less than 1% in the past decade), will compound the government’s ability to meet its deficit reduction aims as less revenue will be generated from tax payers. In an environment of rising bond yields alongside increasing investor fears, we caution that Portugal may suffer to issue and roll over debt this year, either through a lack of demand or exorbitant levels of interest that will force a Greece or Irish style bailout to meet its obligations.
As the EU and Eurozone lack a definitive mechanism to negotiate the sovereign default of member states and Eurocrats remain supportive of the Union in the name of job security, we may well soon see a Portuguese band aid bailout to cover up its fiscal mismanagement.
Matthew Hedrick
Analyst
