Avigdor Arikha

Avigdor Arikha

Inside And Outside, 1996

I really like paintings in paintings… I guess it’s the recursive part that attracts me. 

Fausto Sampaio

Fausto Sampaio

The residence of Melco’s President

When the yield curve indicates that a bailout is imminent [barrier]

The yield curve is the relation between the interest rate (or cost of borrowing) and the time to maturity of the debt for a given borrower.

The following chart shows yield curves for the sovereign debt of three countries: Portugal, Spain and the UK (all in %):



What the chart immediately shows is that Portugal is paying outrageous yields on its debt – something we all we knew already. Now let’s look at the shape of the curve. The yield curve is supposed to be upward sloping. In other words, from the borrowers’ perspective, if you borrow money for a longer period you will offer your lender a higher return (or higher interest). In fact, this is the case for Spain and the UK.

Portugal’s yield curve is now hump-shaped. A yield curve showing this shape is also called “inverted”. This means that yields on 5-year debt are now higher than, for instance, yields on 6-year debt or yields on 30-year debt. This in turn means that investors find it riskier to lend to the Portuguese Government for 5 years than for 30 years.

This is counter-intuitive and only happens in situations when investors expect a period of recession. Or in this case, a bailout (or both). As stated in the FT today (James Mackintosh explains it all in a nice video) one of the factors preventing a bailout in Portugal is pride. The yield curve for Portuguese sovereign debt is indicating that a bailout is imminent (and if that is the case, it is likely that the current Government will be replaced).

Note that Spain’s yield curve does not indicate that a bailout is imminent in Spain.

I have to confess that I am amazed at this Government’s resilience but there is of course no causality link between an inverted yield curve and a change of Government. In my mind the current Government is in the way of change at the moment – from that perspective it should be removed.