Portuguese bond yields hit a three-week high and were on track for their biggest weekly rise since May, as concerns about the country's ratings outlook remained in focus ahead of a Fitch Ratings review later in the day. In neighbouring Spain the yield on a 10-year bond held near a record low hit on Thursday after acting prime minister Mariano Rajoy took a step towards forming a new government in a bid to end eight months of political limbo.
Portugal's 10-year government bond yield rose 9.2 basis points to 3.01 percent. It has risen 29 basis points this week, pushed up after credit ratings agency DBRS warned on Tuesday that pressures were building on the country's creditworthiness. The DBRS rating on Portugal is significant because it is the only one of the four agencies recognised by the European Central Bank (ECB) to give Portugal the investment grade rating it needs to qualify for the bank's quantitative easing scheme.
Fitch Ratings is expected to report on the sovereign later in the day. It rates Portugal BB+ with a stable outlook, while DBRS gives the country a BBB (low) rating with a stable outlook. "The market would have maybe just shrugged off this review ... but now that we have had the revival of the DBRS fears this has taken on more significance," Commerzbank strategist David Schnautz said.
"Everyone will scrutinise what Fitch says because at the end of the day all the ratings agencies look at the same information." Most other bond yields in the region also rose as the day wore on, partly on speculation that the UK could formally begin the process of leaving the European Union early next year.
"I think it's a combination of normal fund flows for this time of the year and the Brexit rumours on the margins," said Lyn Graham Taylor of Rabobank. "But I think the main two stories for this week are the Fed minutes and the DBRS comments on Portugal." Germany's 10-year yield rose 3.7 bps to minus 0.04 percent and further down the ratings spectrum Spain's 10-year yield was 3 bps higher to 0.95 percent, with the spread over German Bunds hovering around 100 bps.
With Portuguese and Spanish bond markets moving in different directions this week, the gap between 10-year yields in the two peripheral euro zone states has widened to 207 bps. That takes the spread back to levels seen in February when concerns about Portugal's banking sector and growth outlook sparked a sharp sell-off in Portuguese markets.
"The DBRS ratings warning this week was a reminder that Portugal could potentially drop out of the ECB's bond-buying programme and people had forgotten about that risk," said Nordea's global fixed income strategist Jan von Gerich. "But Spain is not on the verge of being dumped out of the ECB programme and despite the political deadlock, the economy is doing okay and fiscal developments have been contained."
A hunt for yield in an environment where more than $13 trillion worth of bonds globally yield below zero percent has helped boost demand for Spanish bonds. Signs that eight months of political stalemate may finally be coming to an end have given the market further momentum. Acting prime minister Mariano Rajoy said on Thursday he was ready to face a confidence vote on forming a new government after agreeing terms for a pact with centrist rivals.