China: Can’t Get Enough of ‘Em Portuguese Bailout Bonds!

Word around the forex jungle is that China is interested in bailout bonds… Portuguese bailout bonds. How do you think it will impact sovereign debt concerns in the euro zone?

Last Thursday we saw the euro rally against its major counterparts (except the franc) when news hit the airwaves that China, the world’s second largest economy, is interested in Portugal’s bailout bonds.

Don’t believe me? Just ask European Financial Stability Fund (EFSF) Chief Executive Officer Klaus Regling. He mentioned in a statement last week that China is “clearly interested” in participating in Portuguese auctions next month. He also acknowledged that diversification was a bigger factor in China’s interest, but argued that it still reflected that the country has got swag for the euro.

The good news came at a critical time for the Portugal. Even though it was only on May 16 that EU finance ministers approved its 78 billion EUR-bailout package, the urgency of the auction shows that the country badly needs cash to pay for around 10 billion EUR worth of debt due in June. Next week, officials are aiming to raise 3-5 billion EUR from 10-year EFSF bonds, and another 5 billion EUR from 5-year bonds at the end of the month.

Looking at the euro’s hustle, it seems like investors were able to breathe a sigh of relief at the wake of the news. EUR/USD rallied more than 100 pips and tested resistance at the 1.4200 handle.

Euro bull(dog) carrying bear

But wait! Before you go gaga for the euro like it’s Justin Bieber, you should know that not everyone is convinced that China’s move would provide the currency ample support on the charts.

Recall that EFSF bonds have a triple-A grade. This means that credit ratings agencies think that they’re stable and that investors will fosho get the returns to their investments. And so, China may only be taking advantage of the opportunity to diversify away from U.S. Treasuries and does not necessarily translate to confidence in the debt-ridden countries in the euro zone.

In other words, China’s willingness to buy EFSF bonds does very little to address Greece’s debt problems which has recently been the focus of the market.

EFSF Chief Financial Officer Christopher Frankel also said that the breakdown of investors would probably be the same as the last auction in January. Digging into the EFSF’s books, I found out that China and Hong Kong only bought 6% of the 5 billion worth of bonds that went on sale.

If Mr. Frankel is right, China would probably buy a measly amount of 600 million EUR in a 10 billion EUR-bond sale. Err, that really ain’t much. If Japan made the pinky promise to support the bailout bonds, however, the situation would probably be different. The Japanese purchased the most bonds in January, taking 22% of the total sale.

So in this humble not-so-old man’s opinion, I don’t think the good vibes that might have come from China’s move would last long. Remember that euro zone’s sovereign debt woes are still here and who knows, the slightest bit of bad news from Greece may just send the currency trading lower.

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