The good news is Greece won't default on March 20, and 10-yearborrowing costs for Spain and Italy have dropped below 5 percent.The bad news is similar-maturity Portuguese bonds still yield morethan 13 percent.

Last week, Greece pushed through the biggest sovereignrestructuring in history, with private holders forgiving more than100 billion euros ($131 billion) of debt, a condition for thenation to win the bailout it needs to repay 14.5 billion euros ofdebt coming due next week.

Unlimited European Central Bank loans to banks have halted abond-market rout that prompted investors to drive German yields torecord lows and yield premiums on the securities of its regionalpeers to euro-era highs. The Italian 10-year yield has dropped morethan 150 basis points and the rate on similar-maturity Spanish debtis about 80 basis points lower since the ECB announced Dec. 8 itwould offer loans to financial institutions through two longer-termrefinancing operations.

“The ECB liquidity is life support,” said Robin Marshall,director of fixed income in London at Smith & WilliamsonInvestment Management, which oversees about $18 billion. “They'vebought time but they must use the time to implement proper reform.It's hard to see there not being more defaults, more private sectorinvolvement. It makes it more likely we're going to get anothermarket rout later in the year.”

Portuguese 10-year debt yields 13.71 percent, down from aeuro-era record of 18.29 percent reached Jan. 31 though higher thanits 2011 average of 10.17 percent. Two-year rates of 12.48 percenthave doubled in the past year, though they are down from more than21 percent at the end of January.

The ECB bought short-dated Portuguese securities on Feb. 29,according to two people with knowledge of the transactions whodeclined to be identified because trades with the central bank areprivate. That ended pause of at least two weeks in the centralbank's Securities Markets Program, through which it has boughtalmost 220 billion euros of euro-area government bonds.

Portugal, whose government debt is junk rated at Moody'sInvestors Services, Standard & Poor's and Fitch Ratings, risksbecoming the next nation to need to restructure its debt, accordingto Matteo Regesta, a senior fixed-income strategist at BNP ParibasSA in London. Portugal's deficit was 4 percent of gross domesticproduct in 2011.

'Bond Vigilantes'

“The market doesn't believe that Greece is a unique case,” saidRegesta. “Portugal is very similar. It would be easy to try toplacate and distract the attention of the bond vigilantes, if onlypolicy makers would immediately close the funding gap, pre-emptingany further pressure on the periphery. I'm afraid I don't thinkthat's going to happen.”

Portugal is raising taxes and cutting spending as it fights tomeet the terms of its 78 billion-euro aid plan from the EuropeanUnion and the International Monetary Fund after it followed Irelandand Greece in seeking a bailout in April.

Vitor Constancio, ECB vice president and former Bank of Portugalgovernor, said March 8 that Portuguese austerity measures were ontrack and Greece's debt swap would not need to be repeated. Thefollowing day, German Finance Minister Wolfgang Schaeuble calledGreece a “completely unique case.”

Investors have lost 11 percent on Greek bonds since Dec. 8,according to indexes compiled by Bloomberg and the EuropeanFederation of Financial Analysts Societies. Portuguese bonds havereturned 1.9 percent, lagging behind gains of 15 percent on Italiansecurities, 8.4 percent on Spanish debt and 1.7 percent on Germanbunds, the indexes show.

While last week's swap reduces Greece's privately held debt byabout half, the government's decision to force holdouts toparticipate may backfire by deterring investors from keeping cashin European sovereign debt, said John Wraith, a fixed-incomestrategist at Bank of America Merrill Lynch in London.

“Recent spread narrowing has been driven by the LTROs andshorter term and speculative buying,” said Wraith. “None of thischanges the fact that important, major overseas investors viewrecent developments with suspicion and alarm. With such a range ofdamaging precedents being set, they are highly unlikely to changethat view and return as fundamental, long-term holders of thesebonds for the foreseeable future.”

Italy's 10-year yield was 4.86 percent at 9:47 a.m. London time,down from a euro-era record 7.48 percent on Nov. 9. Spain's 10-yearbonds yielded 5.02 percent, with the rate on German 10-year bunds,the euro region's benchmark government securities, at 1.78percent.

“I'm not forecasting a second default, but the markets certainlyare,” said Bill Gross, co-chief investment officer at PacificInvestment Management Co., which manages the world's biggest bondfund. “The rules have been changed here,” he said in a March 9radio interview with Tom Keene and Ken Prewitt on “BloombergSurveillance.”

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