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Euro Strength at Clear Risk Ahead of Portugal Austerity Vote

Euro Strength at Clear Risk Ahead of Portugal Austerity Vote

2011-03-22 23:25:00
David Rodriguez and Ki Kim,
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The Euro continues to hit fresh highs against the US Dollar, but a standoff on a key legislative vote in Portugal threatens to push the euro zone periphery nation into insolvency and derail Euro/US Dollar strength.

The Portuguese government plans to introduce new fiscal austerity measures as it tries to avoid a European Union bailout and tapping the European Financial Stability Fund (EFSF). The government insists that the additional measures will be sufficient to avoid emergency funding and instead meet the government’s goal of cutting its budget deficit from 7.3 percent of GDP last year to 4.6 percent in 2011. Yet discord from an opposition threatens the key measure, and failure to pass the proposed austerity measure could force Portugal into insolvency and make an EFSF-led bailout inevitable.

One only need look at yields on Portugal’s benchmark government bonds to see perceived default risk for the EU’s 18th-largest country. Portugal's benchmark 10-year bond yield rose to 7.69 percent from Monday's 7.53 percent, taking the premium investors demand over German Bunds to 443 basis points—just short of a record-high.

Portugal Benchmark 10-Year Government Bond Yield

Euro_Strength_at_Clear_Risk_Ahead_of_Portugal_Austerity_Vote_body_Picture_3.png, Euro Strength at Clear Risk Ahead of Portugal Austerity Vote

Source: Bloomberg

Finance Minister Fernando Teixeira dos Santos told parliament that a 10-year yield above 7 percent is unsustainable for Portugal in the medium and long term. In fact, Greece and Ireland were forced to seek bailouts soon after their respective bond yields crossed the 7 percent mark. Mr. Teixeira further warned this week that failure to enact the austerity measure would push the country closer to following Greece and Ireland to an EU-led bailout package. Risks to the Euro are relatively clear. The Euro’s reaction to the Ireland bailout warns that similar action on Portugal could sink the fast-rising currency.

Euro Falls Sharply as Ireland Sought Bailout from European Financial Stability Fund

Euro_Strength_at_Clear_Risk_Ahead_of_Portugal_Austerity_Vote_body_Picture_4.png, Euro Strength at Clear Risk Ahead of Portugal Austerity Vote

Traders are understandably cautious on the Euro headed into tomorrow’s pivotal vote on Portuguese austerity measures. Although we do not know exactly when the bill may go to full vote, we will keep a close eye on newswires and keep traders posted on the DailyFX Real Time News feed. Risks to the Euro are clear, and the single currency could fall sharply on a ‘no’ vote. We view sharp rallies on a successful vote somewhat less likely, and risks seem weighed to the downside through tomorrow’s trade.

Written by David Rodríguez, Quantitative Strategist and Ki Kim, DailyFX Research Team

To contact the author of this report, write to drodriguez@dailyfx.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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