Neil Mehta, Markit
Credit investors have been treating Portugal with increasing scepticism since the beginning of the year. Portugal’s five year credit default swap spread, a measure of perceived credit risk, is 86% wider than at the start of the year according to Markit’s CDS pricing service. Portugal’s five year CDS spread is three times wider than Spain’s, after being less than double at the start of the year, and is also now twice as wide as Italy’s spread.
Having been bailed out by Europe and the IMF in 2011, Portugal has struggled to shrug off its reputation as one of the eurozone’s weaker economies. A large debt overhang continues to be a burden — at 130% of GDP it is one of the highest levels in the eurozone — while economic growth has remained slow.
Problems surrounding Europe’s banking sector this year have also impacted Portugal. In an already fragile banking sector, the country’s biggest bank, Caixa Geral de Depositos, is now in dire need of capitalisation.
Further credit deterioration could mean further downgrade pressure from rating agencies. It could also mean losing access to European Central Bank quantitative easing, should DBRS (the only rating agency to have Portugal as investment grade) decide to downgrade the country. The consequences may well deepen any economic crisis, leaving Portugal in need of another bailout.
Portugal’s troubles have meant government bond returns have underperformed European peers. The Markit iBoxx € Eurozone index has returned 0.97% so far this month, over 1% more than the Markit iBoxx € Portugal index, which has returned minus 0.21%. Spanish and Italian government bonds have returned 70bp and 71bp more than Portuguese government bonds in June.
Year-to-date returns paint a similar picture, with the gap between Portuguese government bond returns and eurozone counterparts exaggerated. Markit iBoxx € Portugal index has returned minus 1.68% so far this year on a total return basis, while broader Europe has seen returns in excess of 3%. While tumbling government bond yields help boost bond returns in Europe, Portugal continues to deal with its own agenda.
