Bonds hit by Portuguese spike and fears over US

Developed world government bond markets suffered another difficult start to the month last week, with a spike in Portuguese yields and fears over America’s AAA rating.

On January 5 Portugal borrowed €500m (£426m) from the markets at interest rates of 3.69%, compared with the eurozone benchmark yield of 0.45%. Portugal is already set to repay or refinance the money in six months, although its deficit will force it to issue vastly more over this year.

Investors are increasingly speculating that Portugal will need a bail-out, following interventions in Greece and Ireland last year. (article continues below)

According to Eurointelligence, the Swiss National Bank has also declined to accept Irish bonds as collateral, fuelling fears that Ireland may need to restructure its debt.

Meanwhile, Bill Gross, the managing director of Pimco, has joined a ­chorus warning that America could lose its AAA credit rating.

Gross, the most senior employee at the world’s largest bond investor, has joined prominent fixed income inves­tors such as Jim Leaviss, the head of retail fixed income at M&G Investments in London, who have said America’s AAA rating is under threat.

Gross has said America’s quantitative easing programme will reduce the dollar’s buying power and cause inflation and potentially higher interest rates for America. He has urged investors to move out of the dollar and into debt, whose interest payments are pegged to rate rises, as well as into sovereign bonds and emerging market corporates with higher initial yields.

In stocks, he has recommended macroeconomically stable names that could benefit from commodity inflation, including Canada and Brazil.

“All investors should fear the consequences of mindless US deficit spending,” Gross says. “Higher inflation, a weaker dollar and the eventual loss of America’s AAA sovereign credit rating are the primary consequences.”

Meanwhile, Andrew Smithers, an asset allocation specialist, has warned that a sharp spike in America’s deficit could hurt the stockmarket. He sees long-term danger signals emanating from the reversion of profit margins, currently at record high levels. The report says it is unlikely America’s budget deficit will decline in 2011 in line with some forecasts, saying profits may well hold up, rather than fall, but only if the deficit remains at about 10%.