Should Portugal join the likes of Greece and Ireland by being the third out of the five PIIGS nations to ask for a bailout package from the EU and IMF? Germany and France seem to think so.
According to an article in German magazine Der Spiegel, rising Portuguese bond yields have raised a few eyebrows among financial hotshots in two of the euro zone’s largest economies.
Remember, government bond yields refer to the rate of return paid to investors lending money to the government. If you’ve been attending your School of Pipsology classes diligently, you’d recall that bond yields usually serve as a gauge of market confidence. If investors are unsure that they’d get paid back, they would require a higher rate of return or yield on the funds they lent.
Last week, Portuguese bond yields rose to 7% – a level which had European leaders doubting whether Portugal could afford to pay back their loaned funds. However, their Prime Minister Jose Socrates refused to give in to peer pressure and insisted that Portugal doesn’t need help from the EU or IMF. He expressed confidence that Portugal would be able to meet its deficit reduction target of 7.3% of their GDP for 2010.
Will Socrates be able to say “In yo face!” to naysayers once the final deficit figures are released on March 2011? Or is he better off taking a page off his namesake’s philosophy book and admit that “I know that I do not know” if Portugal will need a bailout?
While market confidence towards the whole debt situation is low, euro zone nations’ exposure to Portuguese debt is significantly less than that of Ireland and Greece. This means that the prospect of methodical, systemic debt contagion is also less probable. But that doesn’t mean that the possibility of a bailout is nil!
I believe that the bailout will come, but it will take time. Spain, one of the larger nations in the euro zone, is Portugal’s biggest lender. While the EFSF’s 440 billion EUR bailout plan could cover Portugal, the fund clearly cannot cover Spain as well!
Think about it: should the euro zone let Portugal default and bailout the bigger and more expensive Spain, or bailout Portugal and save boatloads of money? Portugal or Spain? That’s a pretty easy decision, don’t you think?
People aren’t optimistic about the situation either. A Reuters poll done over the weekend showed that 44 out of 51 economists surveyed believe that Portugal will need to be saved sometime in the future. Maybe we should do our own survey here in BabyPips.com… It would say “1 out of 1 cartoon-looking bloggers surveyed by BabyPips.com also believe that Portugal will need a bailout.” Hah!
As for the euro, whether it will keep its head afloat or not may boil down to how the how it fares this coming week. Aside from the reports due from the euro zone, Portugal is scheduled to hold a 1.25 billion euro bond auction this Wednesday.
In the past, the results of bond auctions have triggered big moves in the euro. This is because auctions give investors a direct look at how confident the market is in the issuing country’s current economic standing.
That being said, if Portugal can pull off a successful or oversubscribed bond auction, EUR/USD may be able to find a bit of relief and hang above 1.3000 once again. But the upside potential for the pair looks limited since many of the fundamental issues that have weighed down the euro remain unaddressed.
On the other hand, an unsuccessful auction would likely spark another sharp euro sell-off, which could very easily send EUR/USD down to new lows, possibly below 1.2700.
Whatever the case may be, there’s clearly a lot on the line when the bond auction takes place this Wednesday. The question is, will it be a hit or a miss?