Portugal

The reverse dutch auction model for Europe's insolvent countries is dead. Earlier today Spain announced it would cancel its planned bond auction for January 20, and instead plough ahead with syndicated issuance. For those unclear with what this means, Spain is essentially saying the market pricing mechanism on its debt is too transparent and adds "volatility" and therefore the country would rather have banks underwrite the whole issue i.e., take the issuance risk on their books, thus spare Spain the embarrassment of a failed bond auction. And Spain is just the start: Portugal and Belgium have followed suit, in an action that is sure to stretch the already frayed nerves of European sovereign bond investors as this kind of last ditch effort is always taken before something is about to go "snap." From the Irish Times: "Spain's Treasury, facing a volatile market as it looks for ways to keep its debt costs under control, cancelled a bond auction planned for Thursday and said it would issue a syndicated bond over 10 years. Belgium is also seeking an opportunity to place debt with a syndicate of banks and Portugal also plans one for the first quarter, as fiscally stretched sovereign issuers elsewhere in Europe also seek to cut spiraling financing costs." And lest readers get the impression that this is purely a European development, China just announced that it is suspending its sterilization bill sales for the balance of the week. Did the European bond market suddenly die?

The reason for today's most recent bizarro boil up per Bloomberg: "The European Central Bank spent between 1 billion euros ($1.3 billion) and 1.5 billion euros in government bonds in the last two days, according to Nomura International Plc estimates." No news yet on how much Japan, China, the Smurfs, and Uranus ended up having to purchase to bring you today's 1% surge in stocks.

The Bank of Portugal adds that foreign aid would cushion adjustment. And so bailout #3 is virtually in the books. Which means another country is now going to rely exclusively on the ECB. The half life between bailouts is collapsing. Next up Spain.

Reuters reports that Portugal is in the process of making a private placement of bonds, without announcing details on size or the buyer. Our guess: buyer is China, and size is about €1 billion (recall that recently China told Spain it would buy about €6 billion from the three PIIGieS each). We will keep you updated, but this is a revolutionary change in the way bonds are sold to investors as it bypasses the traditional dutch approach entirely. As such, we would not be at all surprised if Goldman is the underwriter. After all this is basically a 144A transaction (although unlike in facebook there is no need for an SPV), and since there is no noise associated with a public offering, the buyer and seller can both pretend things are great until everything collapses in the inevitable post house of cards rubble.

After S&P put Portugal on "watch negative" on November 30, citing "little progress on any growth-enhancing reforms to offset the fiscal drag from these scheduled 2011 budgetary cuts" by the government, today Mark Zandi's rating agency, with a 3 week delay, has decided to prove once and for all, that in the ascent to the rarefied intellectual air of the now obsolete business model of the rating agencies, S&P always takes the not too long bus. In what can be classified as a virtually plagiarized report, Moody's says: "Moody's says that an important driver of its decision to review Portugal's ratings is its concerns over the economy's sluggish growth, driven mainly by weak domestic demand. In addition, deflationary pressures as a result of fiscal consolidation and bank deleveraging may put additional downward pressure on nominal GDP growth." There was a time when the EUR would plunge on news like this. Now that nobody really cares about any newsflow (and certainly not about the rating agency's opinion), this is barely sufficient to push the EURUSD down 40 pips.

Meet the contestants in the European insolvency race, direct elimination round:

For those who don't specialize in sovereign state financial models, I have broken down the anatomy of the inevitable Portugal default into a few simple graphs with direct comparisons to the Argentina default and restructuring. As the equity markets drink the liquidity elixirs, the debt markets are about to enter the greatest string of sovereign defaults in recent history. Many of my next few posts will provide a clear road map of the event. Move over Dancing with the Stars!

Today's much anticipated Portuguese T-Bill auction carried some good and some not so good news. While the Bid To Cover on the €500 million 12 month paper improved from 1.8 to 2.5, the rate on the 1 year issue surpassed 5% for the first time, and came wide of analyst expectations, pricing at 5.281%, compared to 4.813% previously. Per Reuters: " That was higher than the roughly 5 percent that dealers and analysts had looked for ahead of the sale, though the rise in short-term borrowing costs was much smaller than a more than 150-basis point jump at the previous tender in November.  "There is no place to hide on the curve for Portugal anymore. Once again, the auction increases pressure to find a circuit-breaker to limit the damage, which is most likely to mean asking for aid," said David Schnautz, debt strategist at Commerzbank in London." Filipe Silva, debt manager and Banco Carregosa explains why contrary to the EUR's reaction, this is not good news: "This rate is very high and Portugal cannot keep raising its rates at this pace, 47 basis points in just two weeks." Yet despite the weak auction, Sovereign spreads tightened modestly after rumors that the ECB would announce an expansion or a new program to buy peripheral sovereign debt. Which was to be expected: the Portuguese auction was quite irrelevant compared to what happened in Germany earlier, when the country held its weakest 5 Year Bobl issuance in 6 months: in an auction of €4.13 billion in paper, the government saw a mere 1.1 Bid To Cover, the weakest since May, and forcing the government to retain 17.4%, or €0.87 billion of the auction to make it not appear that the auction was a failure.

But while everyone’s eyes are on Portugal, the action is starting to really brew in Belgium and Hungary/Austria, all three of which I’ve mentioned as “potential next legs” in recent pieces. Belgium’s €1.425b 3mo bill auction saw a menial bid-to-cover of 1.48 today, much lower than the 3.52 last month, and yielded 86.4bps, almost 10bps higher than prior. Six months of no government and a 101% debt/GDP aren’t helping to remove Belgium from the cross hairs.

This is getting ridonculous: "On Nov. 30, 2010, Standard & Poor's Ratings Services placed its 'A-' long-term and 'A-2' short-term foreign and local currency sovereign credit ratings on the Republic of Portugal on CreditWatch with negative implications. The transfer and convertibility assessment remains 'AAA'." The only that matters: what does Dagong say. Our clown rating agencies are way overdue for retirement watch imminent. If the market is totally retarded, we guess the EURUSD may be whacked on this news.

The dominoes are starting to fall ...

Although since Ireland is now also wider on the day, it is not really contagion. It is more failed bailout. And the EURUSD is now below Friday close. The market now believes the Irish bailout has failed.

But the real story is that this financial crisis in Europe could potentially cause the break up of the euro and of the European Union.

It is as if Europe is trying to kill the Euro (just as we predicted): the FT reports that according to Fernando Teixeira dos Santos, Portugal's finance minister, the risk that Portugal will have to turn to the international community for emergency financial assistance is high because of the growing dangers of contagion through financial markets that fear the eurozone debt crisis will spread. "The risk is high because we are not facing only a national or country problem. It is the problems of Greece, Portugal and Ireland. This is not a problem of only this country." And just to make it appear sightly less palatable that Portugal is now pointing a loaded gun at its head, dos Santos threw a little of the blame all around: "This has to do with the eurozone and the stability of the eurozone, and that is why contagion in this framework is more likely. It is not because markets consider we have similar situations. They are only similar in what concerns markets, but as I said they are very different. Markets look at these economies together because we are all in this together in the eurozone, but probably they could look different if we were not in the eurozone. Suppose we were not in the eurozone, the risk of the contagion could be lower." And while we are on the daydreaming page, suppose the Euro did not exist: things may have been just a little different, roughly in line with what the euroskeptics have been saying for almost two decades now. Suppose the Fed did not exist either...

The more things are bankrupt, the more things stay the same. Evidence #1: Goldman's FUG (Francesco U. Garzarelli) sends a letter to clients in which he implies that Europe should promptly add Portugal and Ireland to its list of wards of the state, so that the Dow can go back to targeting 36,000 on short notice. Apparently this latest European nuisance (punctuated by the Irish Bund spread passing 600 bps) is too much for Goldman strategists, who are perplexed by this stunning inability of the ECB and EMU to grasp that in this market where the only buyer of everything are Central Banks and no market risk is supposed to exist, that Europe still has refused to step up to the plate and debase their currency by a few hundred bips. And after all, the only reason the EURUSD is trading where it is, is so that it has a whole lot of buffer room to fall.