Portugal Update

With the anxiety caused by the Greece situation alleviated for the time being by last week's successful auction, words of support from Germany and especially France over the weekend, and follow through gains in the Greek debt market, attention may turn elsewhere ahead of Greece's mid-March status report.

Portugal is the likely candidate and although the IMF's Strauss-Kahn says that the Greek crisis will not spread to other euro zone countries, at least Portuguese officials are not as convinced.

Today Portugal announced more plans for fiscal consolidation. While Greece is committed to reducing its budget deficit from 12.7% last year to 8.7% this year, Portugal intends to cut its deficit to 8.3% from 9.3% last year. It projects a 6.6% deficit next year, 4.7% in 2012 and 2.8% in 2013.

Portugal intends to generate a decline in real wages of civil service by capping pay increase below inflation to generate saving as a part of a larger effort to decrease the size of the civil service through attrition. The government also will postpone infrastructure investment, and step up its privatization efforts.

Portuguese debt is rated Aa2 by Moody's, with a negative outlook. Earlier today, Moody's warned of the risks facing Portuguese banks . It noted that "the debt and deposit ratings of Portuguese banks are at risk not only from a potential downgrade of the sovereign rating, but also from an assessment of the government's decreasing ability and potentially, willingness to support the country's banking system."

S&P rates Portugal at A+, with a negative outlook. This is two notches below Moody's and Fitch. Our own proprietary model would put Portugal at single A.

Portuguese 10-year yields are near 86 bp on top of Germany. This is almost half the premium that existed a month ago. The spread peaked on Feb 8 near 160 bp. After Greece (now around 6.22%) Portugal offers the highest 10 year yield in the euro zone (4.04%).

Inflation differentials largely can account for the difference in nominal yields between Greece and Portugal. Greece's year-over-year CPI was 2.4% in January and is expected to tick up to 2.5% when it is reported Tuesday. In contrast, Portugal's year-over-year CPI was 0.1% in January and on Wed, when it reports Feb data, it is expected to tick up to 0.2%.

Looking at 5-year credit-default swaps, Portugal (1.17%) is in third place in the euro zone behind Greece 2.86% and Ireland 1.2%.