Tuesday, January 11, 2011

Investors in Portugal to Receive Back-Room Massage

By Grant de Graf

As anticipated, Portugal and Spain are in focus and at the tip of the scale which is once against testing the strength of the Euro currency and Eurozone. Until now the Euro has survived a number of runs. Initially Greece, then Ireland and now Portugal. The primary trigger was the lack of liquidity experienced by central governments seeking to meet bond obligations and current financial needs. Due diligence reports, compiled when these central governments went to the market to increase their debt exposure, revealed that they were in pretty bad shape. Public reaction ranged from mass panic to demonstrations and even riots. The race was on to target victims who could take the rap.

The Central European Government has achieved a remarkable degree of success, together with the IMF in providing bail-out funds and containing the problem. Their future was at stake. The stronger member countries like Germany, and to a lesser extent France are the paymasters who have been left to hold the can. In response they have sought the imposition of strict austerity measures on ailing countries. Now Portugal is faced with a similar dilemma. Within several weeks, a significant size of of its bond portfolio will become due for repayment. To avoid defaulting, the Portuguese government will need to go to the market to raise additional funds. In boom times this would have been like kicking a ball on to a kid's playground. After the credit crunch and austerity, there is no ball and not too many players who are looking for a game. When investors show their face at the forthcoming auction, in when Portugal is seeking to raise funds in the market through additional bond issues, they will ask many questions and request a show of the books. Portugal officials may well be left pursing their lips and offering investors another glass of wine. This will not satisfy. That is why the European Central Bank is likely to pitch in at the auction with covering bids, mainly to keep bond yields lower than what they otherwise may have been. Secondly, their presence at the auction will also serve to underwrite the bond offers that are being made and to reduce upward pressure on the bond yields. This is like offering investors, the potential bidders for the bonds, with a back room massage to stimulate interest and alleviate concerns.

Of course, like any injury, a massage is always a short term solution to a long term problem.