Euro Update (9) – Portuguese rescue immediacy precipitated by week-end political bickering

On the eve of Portugal’s request that the markets be so kind as to lend it €2 BillionBloomberg, The Financial Times, The Wall Street Journal and even Der Spiegel all seem to agree that Portugal is due to get a bail out sometime soon.
The reports are caused by “a selloff in Portuguese debt Monday [that] prompted the European Central Bank to intervene by buying the country’s bonds, traders said. The ECB’s move stabilized the bond prices of Portugal and other highly indebted countries on the euro zone’s fringe. The interest yield on Portuguese 10-year bonds, a key measure of investor confidence in the country’s debt, rose to around 7.18% on Monday before dropping to about 6.93% amid what some traders called “aggressive” bond buying by the ECB. Late in New York, the yield had risen to 7.12%. The ECB declined to comment on its latest bond purchases”, according to the WSJ. This happened despite China, and more recently, Japan declaring their commitment to helping the Eurozone. So we have to ask what scared the markets off so badly on Monday, that lead to a big enough sell-off that the ECB had to intervene?
Well it’s hard to ascribe causes, but I can think of at least two possible ones, neither of which is purely economic. The FT’s piece sheds some light when it mentions political bickering in Portugal during the week-end. “The dispute has increased uncertainty over the future of the minority government and the extent of political backing for its tough austerity steps as campaigning gathers pace for a presidential election on January 23. The opposition centre-right Social Democrats (PSD) at the weekend called on him to resign if, as many investors fear, Portugal is forced to seek an international financial rescue”. Aletnatively, it is possible that this is some seasonal effect where markets are reacting now because it marks the return of most traders from their Christmas holidays. To be quite honest I’m more prone to follow the FT’s explanation, but who knows, both could be wrong.

Either way the timing wasn’t very kind considering the upcoming bond auction tomorrow. This is all made worse because Portugal may have to inject up to €500Million into the ailing Banco Portugues de Negocios (BPN) . The Portuguese Channel TVI24 in its morning news showed footage of the Administrator of the Bank of Portugal (who is not the Governor of the Bank of Portugal) argueing for the intervention of the IMF and the EU (A Jornal de noticias report confirms this).
This in turn prompted a comment from the Prime Minister Socrates who just gave a press conference. There he argued that the rumours of external rescue, are ignorant of the efforts of the country displayed in the 6,8% preliminary deficit for 2010, below the 7.3% target, that they are rumours and nothing more and that anyone arguing that the IMF (in Portugal, people seldomly mention the biggest rescuer, the EU) needs to come in lacks patriotism and are not valuing the efforts of Portugal (framing, and it’s fairly clear who this was aimed at…).
Socrates is famous for being an optimist but his celebration of his own deficit reducing achievements may be premature, in light of the fact that a large chunk of the deficit reduction was caused by the nationalisation of private pension funds of Portugal Telecom, which may come back to haunt the government in years to come. Moreover, against all odds, the Portuguese government continues to predict deficit reducing economic growth next year, even in light of the Portuguese Central Bank’s forecasts to the contrary.
Despite all this denial, there are reports that the Eurogroup has started to gear up for a bailout. Let’s see how this develops.

Covering the Coverage
Bloomberg gives a very insightful, albeit not fully reliable, description of the upcoming debt auctions: “Portugal plans to borrow as much as 1.25 billion euros tomorrow by issuing debt repayable in October 2014 and June 2020, the nation’s debt agency said Jan. 6. The following day, Spain will auction as much as 3 billion euros of five-year bonds, while Italy will market securities maturing in 2026 and 2015 . The Netherlands is pitching about 3.5 billion euros of debt today, with Germany seeking 7 billion euros tomorrow .”
Here’s why this is not exactly reliable. I checked the Portuguese Debt Agency site and it’s actually €2 Billion = (€750M in 5 year loans) + (€1,250B in 10 year loans). I also checked the Tesoro Publico of Spain and I can’t find a reference, but there will be 2 bill auctions for 3 month and for 6 month bills. This reflects poorly on me, not Bloomberg,btw… Finally, regarding Italy, I have no idea where Bloomberg fished those maturities from. I can’t find a reference to them herehere, nor here. Those sites seem to indicate that the maturity is of 3 and 12 months. Moreover, the 12 month Italian auction for tomorrow seems to be of around €7Billion. It is also difficult to know exactly how much the finance ministry will auction in 3 month bills as it admits that the value of 3 month bills depends on funding needs. Finally, Bloomberg was correct about the Netherlands and probably also about Germany as well, although I read €6B (page 4) rather than €7B, but I might not be sufficiently updated.

Some Final Comments on Background and Triggers

As I said, it is really quite interesting, that although the problem that Portugal has is caused by flawed economic fundamentals, the triggers might political. Portuguese workers are relatively lowly skilled, educational achievement is poor, the savings rate is low, the biggest Portuguese firms operate in non-tradable sectors and the government borrows too much. However, it might be political/electoral bickering/campaigning interpretable as signalling of a minority government’s vulnerability that gets markets nervous.
On the other hand, it was also political/institutional issues that created the incentives for the government to increase labour market security/costs, create a huge non-tradable industry through public infrastructure contracts.
So institutional arrangements influence economic fundamentals which expose the country to financial market fluctuations caused by electoral campaigning. May be…

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