Portugal: Reasons to think contagion will be contained

July 11, 2014

Thursday saw the first meaningful bout of market contagion in Europe (and on into Wall Street) for this year at least and probably some way further back than that. The $64 million question is whether it will spiral or fizzle out.

Portugal’s largest listed bank, Banco Espirito Santo, whose shares were suspended yesterday, is in trouble but to the untrained eye it looks like contained trouble. So was this more of a catalyst for investors already wondering about the durability of strong and long rallies in stocks and government bonds to take some profit out? Or are they right to be genuinely worried?

Answers above my pay grade, I’m afraid, but it brings us back to the warning from the Bank for International Settlements – the central bankers club – nearly two weeks ago that “euphoric” markets had got dangerously ahead of the economies that underpin them. There are certainly signs that the euro zone recovery is gaining no momentum.

The losses are on loans to the business empire of the founding family behind BES and the bank insists it is not at risk of running short of capital. Portugal’s central bank has said similar. Even if that was not the case, the Portuguese government is thought to have ample reserves for bank recapitalizations and the EU rules are quiet clear.

If a bank was about to fall, before any public money was used, shareholders and junior bondholders would have to stump up. So the threat to Portugal’s public finances, at least, would appear to be contained. None of that means that the market wobbles are going to subside quickly and it would be no surprise if a new focus was put on other weaker banks in the currency bloc ahead of stress tests later in the year. Having said that, European shares are being called slightly higher at the open.

Italy provides today’s test of investor appetite, offering up to 7.5 billion euros of short- and long-term bonds at auction. Yesterday, the market sell-off  curbed demand at Greece’s second debt sale since its 2012 bailout. It raised only 1.5 billion euros via a syndicated three-year sale, having aimed for up to double that.

The next leg of fighting in Ukraine could be imminent. Ukrainian government forces have warned separatists in the eastern town of Donetsk that a plan was in place to take back the territory they occupy. The rebels are regrouping for a stand in a city of one million people.

Last night, Ukrainian President Petro Poroshenko told U.S. Vice President Joe Biden that Russia and Ukrainian separatists had refused multiple proposals by Kiev for venues to negotiate a ceasefire.

S&P is due to deliver a ratings review of Ukraine. Its CCC rating already prices in a substantial risk of default and the agency has said that if the country split it would almost certainly renege on its international debts. S&P will also rule on Germany while Fitch will do the same for the Netherlands.
At least two rockets were fired on Friday from southern Lebanon into Israel, Lebanon’s news agency and security sources said. Israel pressed on for a fourth day with its Gaza offensive, striking the Hamas-dominated enclave from air and sea, as Palestinian militants kept up rocket attacks deep into the Jewish state.

Relations between Germany and the United States over a spying scandal took a lurch for the worse yesterday with Berlin telling the CIA station chief to leave the country following allegations that Angela Merkel was among thousands of Germans whose mobile phones have been bugged by American agents.
Both sides are at pains to insist that the enmity won’t spill over into things like U.S./EU trade negotiations, but it could make some aspects, such as on data protection, tougher to agree on. The mood music from Washington is distinctly emollient.

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