Earlier this week, Moody’s (the ever-so-popular credit rating agency) announced that it decided to downgrade Portugal’s debt to Ba2 from Baaa1 with a negative outlook. Since Ba2 is below the lowest investment grade level, it means that Portugal’s bonds are now considered “junk.”
Moody’s cited two reasons for their decision. The first one, as everyone is probably aware of, is Portugal’s high level of debt.
Moody’s is concerned that Portugal will not be able to fully achieve the goals of their austerity and debt reduction programs as agreed upon in the loan deal between the European Union (EU) and the International Monetary fund (IMF).
The second one is contagion fear. In the event that Portugal does not achieve its debt reduction targets, then it may need another bailout package. This time around, however, the possibility of private bondholders also sharing the burden by taking a loss is greatly increased.
The effect of the downgrade was felt by the market immediately. EUR/USD dropped almost 100 pips and the Portuguese 10-year government bond yield surged to 12.72% from 12.18%. Bond yields usually rise as bond purchasers need more incentive to own the bonds of companies, or countries, where the risk of default rises–as has been the case with Greece and now Portugal
But it appears that this ain’t no thang with the European Central Bank (ECB) . In its statement on Thursday, the ECB–after raising rates to 1.50% as everyone expected–also announced that they have temporarily suspended the minimum credit rating threshold requirement for Portugal’s bonds. To put it simply, the ECB isn’t concerned that Portugal’s bonds are now rated “junk” status and that they’d still accept it as collateral for more loans.
Should we even be surprised?
Last year, ECB President Jean-Claude Trichet had also remarked that he would not lower the credit rating threshold for Greek bonds, but after Greek bonds were downgraded to “junk,” he did! The fact is of the matter is that the ECB has already set a precedent. It would have been unfair if the central bank did not extend Portugal the same “courtesy.”
The ECB’s move just strengthens the theory that the central bank will do anything in its power make sure the euro zone does not fall apart, even if it means breaking some rules. We keep talking about defaults all over euro zone, but do you really think the ECB will let that happen?
I don’t think so… for now…