Portugal hopes for normality

Portugal captured fewer headlines than its Iberian neighbour, Spain, but it was the main focus of the sovereign CDS market in what was a quiet week.

The country held its first auction of new bonds since February 2011, before it was bailed out by the EU and IMF later that year. The sale of 10-year debt was well-received - more than €10bn in bids were made by investors, comparing favourably with the €3bn target.

Is this a ringing endorsement of Portugal's credit standing? Not really. In the current climate investor s are attracted to more or less any security that has reasonable yield, and Portugal's bonds were priced at mid-swaps plus 400bps.

Peripheral spreads have tightened across the board since the Bank of Japan announced its massive liquidity injection in April. Technical factors are in the ascendancy - economic fundamentals are being largely ignored, at least for now.

Nonetheless, the CDS market does give us some idea of how investors view sovereign credit between countries. Portugal's spreads are now trading at 340bps, their tightest level since October 2010.

But this is around 100bps wider than Italy and Spain, and nearly 200bps wider than Ireland, another peripheral country that was forced into a bailout. This shows that investors still have a relatively dim view of Portugal.

On a positive note, Portugal's bond issue puts it on the path towards capital market normality. And if it can prove that it has "full access" to the markets, then it will become eligible for the ECB's Outright Monetary Transactions programme, which could further spread tightening.

Under the terms of the bailout, Portugal is required to have complete bond market access by September 2013, but the troika (EU/IMF/ECB) could be flexible on this condition. They have already extended the maturities of bailout loans, and the deadlines for fiscal targets set by the troika have also been amended.

In short, with the support of its bailout masters and the reassuring presence and liquidity provided by the world's central banks, it would take a major negative catalyst to trigger a reversal in Portugal's CDS spreads.

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