Copycat debt swap fears hit Portuguese bonds

Yields on Portuguese bonds have spiked to a euro-era high and could rise further on fears it will follow Greece in seeking to restructure its debt, and with some investors forced to dump the paper after Standard & Poor's cut Portugal's rating to "junk".
Greece and its private sector creditors are edging towards a deal under which private bondholders will take losses of up to 70% on their holdings and swap the rest into new bonds, a banking official close to the talks told Reuters on Friday.
Athens needs an agreement within days so it can secure funds from international lenders to cover a 14.5 billion euro bond repayment due on March 20 and avoid a messy default.
"Portugal certainly (is) the weakest link here," Richard McGuire, senior fixed income strategist at Rabobank said.
"Already the market is speculating on haircuts for Portugal, so there already is Greek restructuring contagion in evidence in Portugal. And I think that will continue."
Portugal was the third euro zone country – after Ireland and Greece – to seek a bailout after its borrowing costs were pushed to prohibitive levels.
Even an agreed restructuring of Greece's debt would be a default, but a voluntary deal would not lead to a payout on credit default swaps that could further unsettle markets.
Greece has said it could force investors to participate by introducing legislation on collective action clauses, however, which would trigger such default insurance.
Euro zone leaders insist Greece is an exceptional case and say other indebted states will not demand similar treatment.
But the yield spread between Portuguese and German 10-year bonds has widened sharply this week on fears Lisbon will do just that.
Investors are currently charging 1,273 basis points more to hold Portugal's debt than safe-haven Bunds, 197 basis points more than a week ago.
Lloyds Bank strategist Achilleas Georgolopoulos said the gap could widen another 100 to 200 bps should the Greeks use collective action clauses.
The Portuguese yield curve is inverted, with two-year government bonds yielding 15.68%, more than the 14.66% yield on 10-year bonds, reflecting market concerns about the risk of default. Yields on longer maturity bonds are usually higher because they are perceived to be riskier.
In contrast, 10-year Irish bond yields have tightened 44 bps relative to Bunds this week, to 564 bps, suggesting the Greek debt swap talks have had little impact on investor perceptions of Ireland.
But Irish debt will also be hit if Greece forces losses on bondholders, Georgolopoulos said.
"If they actually do that, then you could see the spread versus Germany from those two countries (Portugal and Ireland) increase massively. It is evident that especially Portugal will be considered as the next one to do the same," he added.
Ireland has said forced writedowns are not on the table and hopes to return to bond markets next year.
"What will matter for Ireland is the potential growth … that's the main driver of the Irish spreads," said Alessandro Giansanti, senior rates strategist at ING.