Moody’s gets all emotional over Portugal, cuts its debt to junk status

Just as Europe was celebrating the second coming of a Greek bail out for European bankers, and the return of artificially good times to the area, a double shot of reality by the rating agencies arrived.

The first was by S&P stating that any form of a debt deal would be considered a technical default in Greece’s case. The ECB countered that with a state of acceptance of the Greece debt for collateral, as long as one of the major agencies allowed it.

This was followed up by Moody’s which downgraded Portugal sovereign debt. The new report out on Portugal declared that the first bail out, which is still in process of being finalized, would not be enough and that Portugal would need a new second bail out.

Currently Portugal is receiving a $78 billion euro infusion of funds via IMF/Euro sources. These funds are supposed to be enough to handle all needs through 2013. However, it appears that moody no longer expects the private markets to be open for Portugal by 2013 rending this bail out, nothing more than a can kicking contest.

There was a “growing risk that Portugal will require a second round of official financing before it can return to the private market, Moody’s said, and the increasing possibility that private sector creditor participation will be required as a pre-condition.”

The market reaction was quick and not so subtle on that side of the pond

Filipe Garcia, head of Informacao de Mercados Financeiros consultants in Porto, said Moody’s move was “a bit extreme” and was likely to exacerbate concerns over Portugal’s debt.

“The capacity to return to the markets after a while depends on a more global, structural solution by Europe rather than on what each troubled country does. I think it’s too early to think of a second bailout for Portugal right now, not this year at least,” he said.

And from this side of the pond

Robert Tipp, chief investment strategist at Prudential Fixed Income in New Jersey, said the downgrade showed the European debt crisis was unlikely to stop at Greece, which looks set to receive a second bailout.

“Once Greece gets wrapped up, you move on to the next country, and in all likelihood that will be the shape of things to come over the next year or two in the euro zone until the long-term financing trajectory for these countries gets stabilized,” he said.

The market does not expect the European Bankers to figure out a strategy that allows them to keep kicking the can, while the PIIGs stay in the union. The more they try, the more it is obvious that no easy solution exits.

The private market has already discounted the debt and priced it in open market conditions. It is the banks that refuse to mark to market their sovereign holdings.

The realistic outcome is a bifurcation of the union, once all other exit strategy’s for this crisis have been tried and failed. The condition of the Union then is the unknown part.

The implications is going to weight on the localized currency crosses, as nations like England ( $FXB ), Sweden ( $FXS ) , & Switzerland ($FXF ) still have control of their own currencies. The US dollar ( $DXY ) and its trading partners ( $UUP ) will be the most obvious places to watch for the fear to grow in Europe.

Contagion is an interesting event, when it happens, everything changes quickly.

Instead of takings its medicine now and dealing with reality, Europe like the old cartoon character will gladly borrow a burger today, for the cost of two of them on Tuesday. It is almost Tuesday now.