Portugal lost its investment-grade status in 2012 when it was forced to accept a eurozone bail-out, following in the footsteps of Greece and Ireland. While Ireland was upgraded back to investment-grade already a few years ago, and Portugal’s economy and state finances have been improving steadily, S&P’s announcement still came unexpected to most investors.
“This was a total surprise for me. Really nobody was expecting this at this moment, especially because S&P is the most conservative rating agency in my view,” Luis Miguel Alvarenga, portfolio manager at BPI Gestão de Activos in Lisbon, tells Expert Investor. “I was anticipating this to happen in six to eight months, but not already now.”
Markets were equally surprised: following S&P’s announcement on Monday morning, the 10-year Portuguese government bond yield instantly fell more than 30 basis points. The drop, the largest one-day fall since 2010, followed a steady recent decline in yields: year-to-date, Portugal’s 10-year bond yield has fallen from more than 4% to approximately 2.4% after S&P’s upgrade.
That’s of course all to the delight of Alvarenga who, as a Portuguese investor, has an average allocation of 5-7% to Portuguese government bond across his portfolios. “We have selectively increased exposure around the middle of the curve since S&P’s announcement, as we expect it’s only natural for the other rating agencies to follow. The first upcoming announcement is from Fitch on 16 December, and we expect them to also upgrade Portugal back to investment-grade,” he says.
This could trigger the return of international investors, who have been largely on the sidelines since Portugal’s downgrade in 2012, says David Tan, portfolio manager of the JP Morgan EU Government Bond Fund.
“Eligibility to be included in investment grade government bond indices typically require at least two ratings to be at or above the threshold,” he said. “If and when that occurs, we expect further follow-through buying to buoy Portugal government bond prices.”
Patrick Barbe, head of European sovereign bonds at BNP Paribas Asset Management, is equally optimistic. He says Portugal’s export and GDP growth (Portugal’s central bank expects GDP to expand by 2.5% this year) “has increased the attractiveness of the bonds to institutional investors such as ourselves. We are therefore fully weighted.”
Alvarenga, however, warns against excessive optimism. “I don’t see Portuguese bonds perform as well as they have in the past nine months going forward,” he says. “There could be some spread compression, but there will be volatility too and I don’t see too much upside in bond prices anymore.”
After all, the performance of the Portuguese economy is not the only factor driving the country’s these. The ECB is still a big buyer of Portuguese government bonds, and if the central bank tapers its asset purchases, that will have its consequences.