Portugal Bond Yield Spikes on Worsening Political Squabbles

I have been saying that in the face of rising interest rates, the risks of a debt crisis can emerge out of multiple potential flashpoints. 

Portugal could just be one candidate as seen by the unfolding developments in the political spectrum

From Bloomberg;

Portuguese borrowing costs topped 8 percent for the first time this year after two ministers quit, signaling the government will struggle to implement further budget cuts as its bailout program enters its final 12 months.

Secretary of State for Treasury Maria Luis Albuquerque replaced Vitor Gaspar at the Ministry of Finance. That prompted Paulo Portas, who leads the smaller CDS party in the coalition government, to quit, saying the new minister would offer “mere continuity” of the country’s deficit-cutting plans…

Portugal’s 10-year (GSPT10YR) bond yield jumped to 8 percent earlier today, the highest level since Nov. 27, and was hovering at 7.65 percent as of 11:10 a.m. London time. The nation pays an average 3.2 percent for loans it received as part of the aid package.

Prime Minister Pedro Passos Coelho is battling rising unemployment and a deepening recession as he cuts spending and increases taxes to meet terms of a 78 billion-euro ($101 billion) rescue plan monitored by the European Union, the International Monetary Fund and the European Central Bank, known as the Troika. Coelho announced measures on May 3 intended to generate savings of about 4.8 billion euros through 2015 that include reducing the number of state workers…

The difference in yield that investors demand to hold 10-year Portuguese bonds instead of German bunds is about 600 basis points, exceeding this year’s average of 461. The gap is down from a euro-era record of 16 percentage points in January 2012.

The political turmoil in Portugal, which seems representative for most of the crisis stricken Eurozone, has been about the resistance to reform and the struggle to preserve the unsustainable privileges of the political class via the welfare-bureaucratic state.

The failure of the economy to recover has been falsely blamed on “austerity”.

The reality is that there hardly has been “austerity” 

The % change of government expenditures in Portugal as well as most of the European countries (with the exception Ireland and Hungary) has been mostly positive from 2007-2012. 

What has been happening is a decline in the rate of increases rather than a net decline of expenditures.

The same can be seen in % change in debt/gdp.

Yet the preferred path of more regulations and higher taxes (amidst cosmetic reduction of government spending) punishes rather than provides the incentives for the real economy to grow. Thus the austerity strawman.

Such resistance to reform will amplify the risk of a credit event which has presently been reflected on the bond markets. Charts from Zero Hedge. 

While the political class thinks that there is an inexhaustible Santa Claus fund, the markets are saying otherwise.

As of this writing European stocks are trading significantly lower (Bloomberg)

US S&P futures are moderately down. (investing.com)

It remains to be seen if the current deterioration in Europe’s political landscape will worsen market conditions elsewhere

In the meantime, 10 year JGB yields has been trading on the upper bound (.88-.90%) of the current range. A spike beyond the 90s would likely put even pressure on global markets.

Cognitive Dissonance And Inflation

It’s been one heck of a week as global markets appear to be in cognitive dissonance.

One, gold appears to be in a corrective mode. And since gold for me functions as a barometer for the direction of global stocks, the recent consolidation in Gold seems to be having some transmission effects.

Some volatility seems to have emerged in parts of the world markets. Bangladesh’s Dhaka Index recently experienced a violent shakeout with a crash that incited street riots[1], but has rallied intensely to close the week down only 2%.

Where there was no crash the damage had bigger, India’s market (4.22%) fell hard alongside with China (Shanghai 1.67%, Shenzhen 4.59%) as the latter raised bank reserve requirements[2] anew. Another High flying and one of the top gainer for 2010, Peru like Bangladesh experienced substantial losses (4.96%).

On a regional basis, ASEAN and Latin American markets were mostly lower, while East Asia was mixed, whereas major markets in Europe including Portugal whom has reportedly been pressed to accept a bailout have mostly risen. Talk about markets rising as concerns over a crisis ripple.

The Portuguese government has officially declined on the need for a bailout. However like contemporaries Greece and Ireland before her, both eventually succumbed[3] to bailouts. Nevertheless Portugal successfully sold 599 million euros ($778 million)[4] on the back of European Central Bank’s aggressive buying of the Portugal’s offering, aside from declarations of support from Japan and China, may seem to have prevented an auction failure, and thus, may have mitigated the crisis from escalating.

So as we predicted the bailouts, whether direct and indirect, have become a permanent feature of the marketplace until market forces eventually undercuts government ability to do pursue with this strategy.

Some experts say that gold’s decline forebode of a rising dollar that would likewise adversely impact commodity and equity prices. I would deduce that these experts have anchored or fixated their views to the 2008 post Lehman episode.

It isn’t true that a rally in the US dollar automatically means the reversal of the price trends of commodities. In 2005, the US dollar rose alongside with commodities or even gold.

Nevertheless it may seem difficult to become structurally bullish on the US dollar in the cognizance that the US appears as not restricting bailouts on her constitutents but likewise the Eurozone and even the rest of the world.

Inflation Is here

Next, even as gold has been weakening, while emerging market equities have been mixed, commodity markets seem to have picked up momentum. Meanwhile US treasury yields remain elevated from October lows.

stockcharts.com: Surging Commodities, Elevated Yields and Strong S & P

So you have surging commodities, weakening of the US dollar rising equities and higher yields, all of which seem to highlight the return of inflation.

And we seem to be seeing more indications where inflation has been gaining ground over the global economy. Importantly this can be seen even in nations which were supposedly under threat from “deflation”.

The Casey Research[5] enumerates on some of these:

-Consumer prices in December exceeded forecasts, up 0.5%, with core inflation up 1%.

-Producer prices rose 1.1% in December.

-China’s inflation, at over 5%, is beginning to cause problems.

-Import prices into the U.S. are on the rise.

-The European Central Bank is now warning of inflation, and interest rates there continue to rise. Back in the U.S., the rise in interest rates is becoming persistent, with 10-year Treasury rates moving from 2.57% in November to 3.31% today –

And the sequence of how inflation percolates as seen in the Austrian framework as aptly described by Gerald O’Driscoll[6],

``In the Mises/Hayek theory of economic fluctuations, the transmission of monetary shocks works through producer prices and incomes, and only later consumer prices. No measure of consumer prices, and certainly not a subset of consumer prices, is an adequate gauge of inflation.”

And I would further add that Wall Street seems to be acting based on these premises as banks cut holding of US treasuries at the fastest pace since 2004[7].

All the seemingly cognitive dissonance seen in the marketplace appears to highlight on the growing recognition of inflationary forces gaining traction.

At the end of the day, we should realize that inflation and volatility are like twins.

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[1] See Bangladesh Stock Market Crash: Evidence of Inflation Driven Markets, January 11, 2011

[2] Strait Times, China reserve requirements raised to tame inflation, January 16, 2011

[3] Wall Street Journal Blog Portugal Bailout Denial: Sure Sign One Is Coming Soon?, January 11, 2011

[4] Businessweek/Bloomberg Portugal’s Borrowing Costs Fall at 10-Year Bond Sale, January 16, 2011

[5] Gold-speculator.com Let Us Print Notes!, January 14, 2011

[6] O’Driscoll, Gerald Inflation Is Here ThinkMarkets.com January 13, 2011

[7] Bloomberg.com Wall Street Dumps Most Treasuries Since 2004 on Growth, January 10, 2011