January 17, 2012 – 6:38 p.m.
By David Oakley

Portugal is trading in default territory after investors offloaded the country’s bonds this week amid rising fears of contagion. Worries are mounting that the private sector and Greece will fail to agree a restructuring package for Athens’ debt.

Many investors were also forced to sell Portuguese bonds after Standard & Poor’s downgraded the country to junk on Friday. Other funds sold Portuguese debt after Lisbon was removed from Citigroup’s European Bond Index, which these investors track, because of its fall to junk status.

All three main credit rating agencies, S&P, Moody’s, and Fitch, rate Portugal as junk, below investment grade. In the eurozone, only Greece is also rated junk by all the agencies.

The markets are pricing in a 65 per cent chance that Portugal will default over the next five years, according to credit default swaps as these instruments, which protect investors from default, leapt to record highs this week.

Portuguese bond prices have slumped to levels considered by many investors to be in default territory. Bond prices for benchmark 10-year debt were trading at 52 per cent of par, recovering from levels below 50 per cent on Monday.

Portuguese 10-year bond yields, which have an inverse relationship with prices, jumped to euro-era highs of 14.40 per cent on Monday. They eased back to 14.12 per cent on Tuesday. Before the S&P two-notch downgrade late on Friday, yields were trading at 12.45 per cent.

Elisabeth Afseth, fixed-income analyst at Investec Capital Markets, said: “The growing worry that Greece will default is now hitting Portugal because of contagion fears. If Greece defaults, then the worry is so will Portugal. We have seen how quickly this crisis can spread.”

Fitch, the rating agency, warned on Tuesday that Greece was likely to default in March when Athens is due to pay €14.5bn in bonds.

To read entire story, click here.