Divyang Shah, Senior IFR Strategist
As with other programme countries we are at a crossroad where the political establishment is reflecting the wider voter fatigue with regard to austerity.
The reappointment of the FinMin is proving to be the trigger for a political crisis that is likely to lead to early elections. How much instability this creates is difficult to tell at this stage, but it is important to remember that both the parties in the current coalition government have signed up to the MoU with the troika back in 2011.
If the current coalition government does not survive, then the two members of the existing coalition (CDS with 108 seats or PP with 24 seats) will likely be in any new government that is formed in the 230 seat parliament. The problem clearly is that we could be in for continued instability as any new formation could see a minority coalition government.
What is likely is that the austerity fatigue will result in a dilution of austerity targets to keep politicians on track.
The importance of making sure that hiccups in Portugal are limited stems from a desire to:
1) make sure the sovereign is able to exit the bailout programme and access funding markets and
2) not rock the boat regarding Ireland and its desire to have access to market funding.
Both Ireland and Portugal had been making good progress toward the goal of funding themselves in the market, but the road has become rockier following the Fed’s desire to shift market expectations toward tapering QE this year.
Remember that unlike the old SMP programme from the ECB, the OMT cannot play its role in trying to deal with dysfunctional bond markets.
Without a buyer of last resort, the risks are for more in the way of upside on Portuguese sovereign bond yields. The key focus over the coming days/weeks is whether weakness on Portugal will be contained and prove less contagious.
We suggest Portugal will be less contagious as, after four years of the eurozone crisis, investors are by now more cognisant of the risks they are taking regarding eurozone peripherals.
Also more recently, domestic investors have shown a tendency to be more supportive of their local markets, especially in Spain and Italy; such support will likely continue.
