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Portugal faces threat of junk status and loss of 'QEligibility'
February 12, 2016 / 3:24 PM / 2 years ago

Portugal faces threat of junk status and loss of 'QEligibility'

* 2016 budget makes DRBS downgrade more likely

* Junk status would make sovereign ineligible for QE

* Portugal 10-year yields rise to two-year high

By Abhinav Ramnarayan

LONDON, Feb 12 (IFR) - Portugal’s government bond yields have risen to their highest levels in almost two years as worries grow that a downgrade could bar the country’s bonds from the European Central Bank’s quantitative easing programme.

Most eurozone sovereign bonds are benefiting from a flight-to-quality bid, but Portugal’s 10-year bond yields breached the 4% level for the first time since July 2014, reflecting concerns that the country’s new left-leaning government is steering an economic course at odds with the European Union and potentially with ratings agencies as well.

That level is by far the highest since the ECB began its 60bn-a-month asset purchase programme in March 2015, when Portugal’s 10-year yields touched a low of 1.56%.

Currently, Portugal’s bonds are rated as junk (Ba1/BB+/BB+) by the three main ratings agencies. Only DBRS gives an investment grade rating (BBB), allowing the ECB to include Portuguese government bonds in the QE programme. DBRS is due to issue its next assessment in April.

”The rating agencies should share our very sceptical take on the new government’s 2016 budget,“ analysts at Commerzbank wrote in a research note. ”Hawkish comments from Fitch and S&P in March could be the trigger for investors to price in an increasing downgrade risk by DBRS on April 29.

“This would cause the loss of ECB ‘QEligibility’, which would probably send PGBs into a tailspin in absence of a major stabilisation in risk sentiment.”

The central bank can only buy junk-rated government bonds if a country is involved in a bailout programme, as it has done for Cyprus and Greece. Portugal, however, is no longer in a programme, having repaid all of its bailout money in January 2015.

“For Portugal this is a huge downside risk, and it could also raise questions about other parts of the periphery,” said Hetal Mehta, senior European economist for Legal & General Investment Management.

“People would have concerns about unresolved questions in Spain, and whether eurozone countries start passing budgets that are taking off track from debt sustainability,” she said.

THE QE EFFECT

Portugal’s government bonds - like others in the eurozone - have benefited massively from the ECB’s intervention.

At the height of the eurozone sovereign debt crisis in 2011, the country’s benchmark 10-year bond yields rose to a high of 17.4%. Though the EU stepped in to contain the worries, that bond was trading well in excess of 7% as recently as September 2013.

Speculation that the ECB would launch QE started to gain weight in 2014, resulting in a steady rally that pushed the 10-year yield to 1.55% by mid-March 2015, 45bp inside 10-year US Treasuries at the time.

The consequences of exclusion from QE would be severe, and some believe the ECB will not allow it to come to pass.

“It’s not in the interest of the ECB or the eurozone authorities to see Portugal fly back into crisis as a result of the actions of a credit rating agency,” said Mark Dowding, co-head of investment-grade debt at BlueBay Asset Management.

“I would be inclined to believe they would amend the laws to make an exception,” he said. (Reporting by Abhinav Ramnarayan, editing by Matthew Davies)

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