Apparently, reports have been spreading that EU officials are getting concerned on Portugal’s capacity to fulfill its financial obligations beyond March 2011. Word on the street is that a bailout plan is already in the works, and that Portugal will be asking for it in April.
Is there any truth to these rumors? After all, Portugal’s officials have been adamantly denying that the country is NOT in line for a bailout. I’m not convinced though, since there are a lot of signs that Portugal may indeed need some form of help.
For one, two weeks ago, Portuguese 10-year government bond yields reached new highs at 7.63%, indicating that traders are growing very very concerned about the country’s ability to pay off its debts. As a result, the European Central Bank (ECB) chose to step in and purchase Portuguese bonds in order to bring down yields.
And don’t forget the credit rating downgrades! In December, Fitch downgraded Portugal’s credit rating to A+ from AA-. Also, other famous credit rating agencies like Moody’s and S&P have warned that they could also downgrade Portugal’s credit rating if it doesn’t get its finances under control.
I wouldn’t be surprised if you say that you’re having a déjà vu because we heard the same “No, thank you” rhetoric from Ireland before it accepted a bailout from the European Union (EU) and International Monetary Fund (IMF).
Although Portugal’s banking sector is relatively smaller compared to that of Ireland and most euro zone members, investors are still worried of a possible default. Why, you ask?
Well, it is primarily because of Portugal’s closeness to Spain. And I’m not just talking about the two countries being a stone’s throw away from each other!
The thought of Portugal failing sends shivers down the EU’s spine because Spain is Portugal’s biggest lender. In fact, a few market junkies did the math and estimated that Spain is holds around one third of Portugal’s foreign-owned debt.
There is no doubt that the European Financial Stability Fund (EFSF) will be enough to cover Portugal’s debt if necessary. But Spain? Err, that’s a different, totally hair-raising story. Being the fourth largest in the euro zone hood and equivalent to Ireland, Greece, and Portugal combined, Spain will not only leave the EFSF drained, but will also send the EU on its knees, scrambling for euros!
And so, I bet my two cents that Portugal will be force-fed with a bailout in order to reduce Spain’s exposure. Of course, this will be at the expense of Portugal’s track record and credibility. In fact, Germany and France are already pressuring the Portuguese to accept a bailout!
If Portugal DOES ask for a bailout though, we might see the euro visit the pip deeps once again. Remember those bearish days in early 2010 when EUR/USD traded below 1.2000, and the Swiss National Bank (SNB) intervened in markets like there was no tomorrow? That was around the time Greece was in hot water over a possible bailout!
Near the end of the year the euro also tumbled on Ireland’s bailout concerns. Fortunately, in both cases, the euro shot up as soon as the Greece and Ireland accepted their bailout packages.
This time around you may want to watch for EUR/USD‘s possible resistance at 1.4000. Since the level is almost at the top of a descending trend channel and Stochastic is almost in the overbought level, it might not take much goading for the currency bears to start hustling the euro to the possible support at 1.3000.
Though rumors of Portugal’s possible bailout have already spread like wildfire in markets, Portugal failing is simply unfathomable. Aside from having more time for improvement than the other troubled euro zone economies, Portugal is just simply too attached to Spain! But, as Dr. Pipslow always says, you gotta be prepared for every market scenario!