Portugal upgraded by Moody's that downplays BES concerns

Moody’s upgraded Portugal’s sovereign rating by one notch to Ba1 and stable outlook on Friday evening following market close. Portugal is close to regaining investment grade status with only one notch missing from Moody’s and Fitch, while S&P is still two notches below investment grade level.

The rating upgrade is based on: “1) Moody's expectation that fiscal consolidation will remain on track despite unfavourable rulings by Portugal's Constitutional Court. This should support a gradual reduction in the very high public debt burden in the coming years. In addition, Moody's does not expect that the current uncertainties surrounding Banco Espirito Santo will have a material impact on the government's balance sheet.” and “2) The government's comfortable liquidity position, with regained access to the public debt markets and sizeable cash buffers. Moreover, Portugal concluded its three-year EU/IMF support programme in June.”

The timing of the rating action came as a slight surprise as Portugal was not scheduled in Moody’s sovereign release calendar before 5 September. However, Moody’s states that “the conclusion of the review, which began in May 2014, necessitates this rating action being released on a date not listed for this entity.”

We continue to expect that Portugal will be upgraded to investment grade later this year. Portugal is in many ways following in the footsteps of Ireland with a clean exit, a high cash balance of around EUR20bn, an elimination of the current account deficit, a fiscal improvement on track, a government debt that is set to decline over the coming years and a strong commitment from political leaders. Like Ireland, we expect Portugal to be able to harvest the efforts in the form of further rating upgrades later this year.

Moody's has Portugal up for review on 5 September and Fitch is following on 10 October – both rating agencies are just one notch away from investment grade and Fitch has Portugal on positive outlook. S&P, which has Portugal two notches down from investment grade, is following on 14 November. It is likely that Portugal could benefit from index inclusions later this year as many indices, such as for instance Iboxx, only require two investment grade ratings for inclusion.

The new ECB measures including a targeted LTROs should in particular be beneficial for Portugal, which is characterised by a relatively indebted corporate sector. Banks should be able to secure much cheaper funding for corporates via the T-LTROs.

We continue to have a positive stance on Portugal and 10Y Portugal was also one of our top trades for this year. Portugal has been the top performer in the EUR government bond market this year only surpassed by Greece. Our positive view is also reflected in our current trading recommendations: