What Happened in Portugal?

Portugal's minority center-right government offers collapsed.  It was less than two months old.  Its downfall made possible by the willingness of the Socialists, the main opposition party to form a vast majority with the Left Bloc, Communists, and Greens.  They garnered 123 votes within the 230-seat parliament to defeat Coelho's program.  Coelho led a majority government until last month's election that saw it reduced to a minority.

The next step is not immediately obvious.  There are three general options.  First, President Silva can title Costa, the head of the Socialists, to form a brand new government.  Of course, this is the preference of the loose coalition he led to defeat Coelho's program.  2nd, Silva could seek an alternative prospect.  This does not seem to be a particularly compelling path.  Third, Silva could allow Coelho to serve as a caretaker till they hold new elections, most likely in Q2.  This would be quite political and controversial.  Yet by allowing Coelho to form a minority government with out giving the left parties an opportunity to form a majority government last month draw a great deal of criticism. 

Another wrinkle is that President Silva, prime minister 1985-1995, is due to step down within January.  He became President in 2006 and re-elected this year. 

There was ostensibly concern that the left coalition would not be stable.  However, the subtext was that the left would antagonize the official creditors.  There are variations among the left, but there is a joint distaste for the austerity that the lenders demanded in exchange for aid which Coelho accepted.  Still, the different daily activities promise to erupt, and potentially quickly.  Costa wants to unwind some public sector salary cuts, and bolster loved ones income by taxing inheritance of more than one mln euros, looking at changing the income tax brackets, and increasing the minimum salary.  The Left Bloc wants to restructure the country's debt while the Communists want to prepare to exit EMU.

Yesterday's developments are not an unexpected.  It has been a bit more than a 7 days in the making.  Over the past 5 sessions, Portugal's 10-year bond yield rose 20 bp, probably the most in Europe.  Portuguese equities have also underperformed, dropping 4.6% in the last five sessions.  In comparison, the actual Dow Jones Stoxx 600 is off about 0.6% within the same period.

To be obvious, Portugal not currently on an international assistance program.  This gives the official creditors less influence than they had over A holiday in greece.  Still, if the EU selected it could sanction Portugal if it misses its fiscal targets.  The main rating agencies place Italy at BB+.  Our proprietary model puts it at BBB-, simply into investment grade.  From the ECB's point of view, that fact that DBRS has Portugal in investment grade status is important.  If DBRS were to cut Portugal's rating, there is risk that the ECB concludes that Portugal no longer qualifies under the asset purchases strategy nor could they use government bonds for collateral with regard to borrowings from the ECB.

Portuguese political developments need the context of the push back against austerity.  Syriza in Greece, chastened by summer and spring events, is still struggling to satisfy the creditors’ demands for the next tranche of assistance.  Left of center governments are in France and Italy.  France seems to be pushing with regard to yet more forbearance from the European union for the 2016 budget target.  Italy's problem is not the deficit but the mountain of financial debt.  Spain has elections next month, and Prime Minister Rajoy appears to be seeking a more sympathetic ruling by the EU.

The Fed is now more widely seen raising rates a fortnight after the ECB eases policy further at the beginning of next month, so the euro remains on the defensive.  Recall that in the Greek drama, the actual euro never revisited the 03 lows (~$1.0460).  In fact, it did not go back below $1.08 until last week.  Portuguese developments may consider further on Portugal resource markets, but the situation appears far from a systemic risk.

Portuguese Politics Takes the Lightening Rod from Greece is actually republished with permission from Marc in order to Market