Rational Rates

File this under: Who’da thunk it two years ago? Portugal auctioned 10-year debt on Tuesday at rates likely to be around 5.5% (the yield 10-year notes are fetching in the secondary market). This is a full 120 basis points lower than the prior 10-year auction—over two years ago. Spreads over German bunds are also skinnier: 4.2% compared to a whopping 16% in January 2012.

All terrific news for Portugal. The 10-year auction means Portugal has successfully raised debt at every maturity it currently issues. Even better, Portugal is done financing itself for 2013 and may start auctions to cover 2014 needs.

The news isn’t being met with cheers on all fronts. Portugal isn’t the only low-rated issuer enjoying relatively lower rates—the same is generally true across all forms of low-rated debt. And some argue low rates on “junk” might foster a dangerously blasé attitude toward risk.

Sure, 5.5% on junk-rated sovereign debt might seem low—in a vacuum. But we don’t live in a vacuum. We live in a world where low-risk benchmark rates globally are at or near generational lows. Spreads between highly rated and high-yielding debt, though narrowing, are still plenty wide, and wider than they were in the run up to the 2008 credit crisis. Then, too, spreads normally narrow when expectations for future economic growth improve—about where we are regarding the eurozone.

Plus, those rates don’t get so darn low by themselves. It’s true, central banks are acting to put downward pressure on certain types of long-term debt. That’s one factor. But investor demand plays a huge part too. If investors are sick and tired of low-yielding vehicles and begin chasing yield (hence, pushing down rates), eventually some of that enthusiasm should find its way to equity markets which, long-term, have provided the best return for your liquid buck. And that melting skepticism should be another bullish feature for equities.

Beyond that (bullish) sentiment feature, remember that markets look forward. Portuguese economic news hasn’t been great—but in capital markets, expectations can matter more than reality. Utter economic disaster has long been expected, yet hasn’t arrived. Rather, Portugal (and the rest of the troubled periphery overall) continues making slow progress—agonizingly slow, but still progress—toward competitiveness reforms. Prime Minister Cuelho (who sailed through a recent no-confidence vote) just announced plans for increased public spending cuts, including cuts to the government workforce—and Portugal now qualifies for its next round of bailout financing. It’s looking increasingly likely Portugal will be able to soon return fully to credit markets, making a second bailout unlikely.

We rather doubt economic progress is fast. We also doubt Portugal becomes a model of efficient capitalism—at least any time soon. (It is, after all, still in Europe.) But the eurozone isn’t a smoking ruin and, in fact, the region is overall expected to return to growth in the back half of 2013—and most economic data is trending that way. That is vastly better than what has long been expected—hence, the markedly lower Portuguese rates. Seems rational to us.