Portugal and Greece Downgrades Offer Silver Lining for Yield

On Thursday, Moody’s (MCO) cut the outlook for the sovereign debt of Portugal and put Greece on negative watch for a downgrade, signaling growing concern over spiraling debts. Just as with Spain and Ireland which I discussed earlier, Portugal and Greece are smaller countries within the Eurozone with large fiscal problems due to the recession. For example, the Wall Street Journal says that Greece expects a budget deficit of 12.5% of GDP this year – that’s more than 4 times larger than the limit set by the Maastricht treaty.

Bonds sold off on the news. The Wall Street Journal reports:

The news spooked investors in government bond markets. The yield spread between 10-year Greek government bonds and comparable German government bonds, or bunds, widened to 1.42 percentage points from 1.36 points. The impact was milder on Portuguese yield spreads, which widened to 0.56 point from 0.54 point against German bunds, because a possible downgrade appeared less imminent.

Moody’s said it hoped to complete the review process promptly, and within three months in the case of Greece. It added that it might keep Greece on a negative outlook even if it decides upon a downgrade.

Standard & Poor’s downgraded both Portugal and Greece in January, while Fitch downgraded Greece last week and revised its outlook on Portugal to negative in September.

And we should certainly expect these downgrades to continue. Back in January, when Portugal was downgraded, the spread to German Bunds moved out to a 12-year high of 146 bps. We are now only 4 beeps lower than that. So, that sounds bearish for their bonds. However, there is a silver lining as Peter Schaffrik of Commerzbank explains in the video below. Bond investors are incredibly starved for yield and that means there is a good bid for these sovereign issues as they offer relatively more yield pickup than German Bunds.

On the other hand, Chris Wyllie of Iveagh says he is zero weight in bonds now because even these bonds and corporate issues simply do not have enough yield to make them attractive.

You should see this as further evidence that stocks are being artificially buoyed by an increased risk appetite driven by low interest rates.

Comments

[Formyx:]

Unlike California that can potentially get some transfers from the feds, Ireland, Portugal,Spain, Italy and Greece are on life support w/o obvious solutions.

I am still perplexed why people buy the Euro.

Nov 01 10:18 AM

[svosavvy:]

good article and good points. Right now I can barely stand the idea of bonds, there is just no yield, so I stay horrifically out of balance. I am afraid to pull the trigger on these historically low yields as am afraid I will be stuck with them if the par sinks in a potentially high rate environment which may be on our horizon. I bought some TIPS in the spring, but, that is about it. Almost bought some 10yr GE program notes for 5.5 yield. So yeah I am artificially overweight stocks and cash because nothing I see from the fixed market piques my interest. I also feel that investment in junk debt while giving higher yield also would suffer from the sinking par blues if rates take off in a couple years. I think the fed walking away from the treasury markets will allow bidders to take up the yield in the future.

Nov 02 10:05 AM