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Monday, January 16, 2012 2:43 PM

Portugal Downgraded to Junk; Bond Yields Soar; Record Spread vs. Germany; Portugal to Follow Greece Into Default Abyss

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Portugal is poised to quickly follow Greece into the default abyss following a debt downgrade to junk status by the S&P on Friday.

The Wall Street Journal reports Portugal's Bond Yields Rise Sharply After Rating Cut To Junk

Portuguese borrowing costs rose sharply Monday as some investors were forced to sell their government bond holdings after Standard and Poor's Corp. downgraded the country to junk status late Friday.

Portugal is now rated as non-investment grade by all three major rating companies. Moody's rates the country at Ba2, Fitch at BB+ and Standard and Poor's at BB.

Non-investment, or junk, bonds have an increased risk of default and pay a higher yield than investment grade bonds to compensate investors for holding the extra risk.

The yield on the two-year and five-year government bonds rose in excess of two percentage points Monday to yield 13.49% and 16.80%, respectively, while the 10-year benchmark rose by just over one and a half percentage points to yield 13.55%, according to data from Tradeweb.

"Now that Portugal is rated as junk by all three agencies, there is forced selling by investors as it [Portugal] is removed from various bond indices and funds," noted one trader familiar with the matter. "It doesn't help that the markets are thin due to the U.S. holiday which makes price movements even more erratic."

Investors are also worried that Portugal may have to follow Greece and re-structure their government debts as they are unable to access the funding market.

The spread between Portugal's government bonds and German bunds hit record levels Monday with the 10-year spread widening by over one and a half percentage points to 1225 basis points.
Portugal 2-Year Government Bonds

Portugal 10-Year Government Bonds

As shown in the above chart, yields continued to rise on Monday, after the WSJ article was written.

Graphs in the above charts are not current, but the summary quotes on the left side of the chart are accurate.

The yield on two-year Portuguese bonds is 15.78 and the 10-year yield is 14.41. Thus, the yield-curve is inverted once again and that is a sign of severe stress.

Given that the Ducks are Lined Up for Greek Default, it's time to look ahead. A Greek default may be priced in, but what about Portugal or Spain?

Mike "Mish" Shedlock
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