Portugal Shadows Yellen, Key NZ CPI Next

A complicated bankruptcy in Portugal dragged down the euro Tuesday, overshadowing Yellen and US retail sales. On the day, the best performer was the pound on high inflation numbers while the loonie lagged on expectations of a dovish Poloz. China GDP and New Zealand CPI are up next.  

Markets hate complicated bankruptcies; they despise them when they involve financial companies. A complicated, incestuous bankruptcy in Portugal has traders selling first and asking questions later. Taking a close look at the risks, the problems are likely contained.

The source of the worry is Portugal's second largest bank, Banco Espirito Santo. A company that owned 25% of the bank was forced to sell off 5% at a firesale prices on Monday to prevent a bankruptcy. But today the 49% holder of that parent company, called Rioforte is reportedly headed for bankruptcy.

That headline hit just before Yellen's testimony and sent a shudder through euro traders. The initial kneejerk higher in EUR/USD on Yellen sent the pair to 1.3610 but Portuguese worries later sent the euro down to 1.3562.

No one is sure how deep the problems run because there is yet another parent company of Rioforte and the kicker is that all of them are largely or partly owned by the same family. What's spooked traders is that some very suspicious loans were made to those companies by a telecom company owned by the same family and at the bottom level the bank was advising clients to buy that same debt.

Here's the bottom line for euro traders: It's probably ok if all the parent companies collapse so long as the bank is ringfenced. Shares of the bank are extremely distressed so trouble there is priced in.

Another negative scenario is if the government is forced into bailouts but PM Coelho has practically ruled that out. Baring either of those scenarios, which are low probabilities, the fears will subside.

Meanwhile, Yellen's commentary largely followed the scenario we laid out as it mirrored the patient, wait-and-see approach from Lockhart on Friday. We're puzzled why traders continue to position for hawkish comments from the Fed chair.

Looking ahead, China GDP is due at 0200 GMT and expected to rise 1.8% q/q but there could be a downside surprise priced in because of soft trade figures. At the same time, industrial production and retail sales will be released.

The more tradable headlines might be on New Zealand CPI at 2245 GMT. Prices are expected up 1.8% y/y. The kiwi fell hard on risk aversion Tuesday ahead of the 2011 high -- a soft CPI print could mark that level as an interim high.