Portugal's bond market tanks as crisis deepens

Lisbon. Portugal
Renaud Visage | Digital Vision | Getty Images
Lisbon. Portugal

The yield on Portugal's benchmark government bonds surged on Friday, following demands for a renegotiation of its bailout program, reigniting investor fears about the deteriorating political situation in the country.

Portuguese 10-year government bond yields rose to 7.77 percent at lunchtime on Friday, up from 6.88 percent on Thursday, before paring back slightly. The country's 5-year government bond yields increased from 6.57 percent on Thursday to peak at 7.72 percent on Friday, before falling back to 7.4 percent.

(Read More: Recovery in Europe's Periphery? Not So Fast)

On Friday, the leader of Portugal's socialist opposition, Antonio Jose Seguro, told parliament that Portugal must end its commitment to austerity.

"We have to abandon austerity politics. We have to renegotiate the terms of our adjustment program... The prime minister has to recognize publicly that his austerity policies have failed," Seguro said.

Alessandro Giansanti, a senior interest rate strategist at ING, said that Friday's jump in bond yields was in direct response to Seguro's comments.

"The socialist party wants to renegotiate the terms of Portugal's bailout agreement, and this has resulted in market jitters," Giansanti told CNBC. "These comments suggest there is an increasing risk there will be a change in the political situation in Portugal, potentially with less tough bailout conditions."

(Read More: Why the EuroZone Crisis is Over…Until September)

He added that Seguro's demands throw further doubt on the government's ability to hold together until the next general elections, and make any cross-party agreement look unlikely.

Jennifer McKeown, European economist at Capital Economics, agreed. "Markets are watching the flow of news closely and this latest development means it looks more likely that Portugal is going to renegotiate its bailout program," McKeown told CNBC.

"That means more time, more money — and makes it even more unlikely that the country will be able to exit its bailout next June as planned."

Meanwhile, Portugal's finance ministry was granted a delay in the next review of the country's bailout program by international lenders, a somewhat surprising move given recent warnings from the troika ordering Portugal not to deviate from its bailout program. The Troika will now carry out its eighth and ninth review of Portugal's progress in its bailout in late August and September.

It came just days after Greece secured new funds from the International Monetary Fund, the European Central Bank and the European Commission, known as the Troika, despite criticism that the country's reform program is not moving fast enough.

The crisis in Portugal blew up after two government ministers resigned over the austerity program last week, threatening the stability of the government and the economic reforms the country is introducing.

Nicholas Spiro, managing director of Spiro Sovereign Strategy, said the resignation of former finance minister Vitor Gaspar had "opened a Pandora's box."

"Portuguese debt is being hammered. While yields were rising long before Gaspar threw in the towel, his resignation has turned a mild sell-off into a rout," he said.

"In the space of a fortnight or so, Portugal has rapidly become the focal point for market nervousness in the eurozone periphery. With Spanish and Italian yields still at pre-crisis levels, Portugal's bond market sticks out like a sore thumb."

Portuguese 10-year government bond surged past 8 percent last week, amid the political instability, before falling back.

(Read More: Portugal Fires Warning Shot for Austerity in Europe)

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