The 'temperature is rising' in Portugal

At its latest policy meeting on Thursday, the European Central Bank announced it was extending its quantitative easing program until at least December 2017, while at the same time trimming its asset purchases to a pace of €60 billion a month, down from €80 billion.

While many were quick to suggest that this was the beginning of the ECB tapering its asset purchases because they are buying less each month, ECB head Mario Draghi dismissed this talk.

"There is no question about tapering," Draghi said at this press conference following Thursday's decision. He added that tapering " has not even been discussed" and that tapering could only happen if the central bank has a policy " whereby purchases go to zero."

That hasn't stopped peripheral bond markets - in Italy and Portugal - from coming under significant pressure. The worry is that if the ECB were to taper its asset purchases then demand for those bonds would dry up, and peripheral Europe could find itself in the next leg of its seemingly never ending debt crisis.

Portugal under the radar

Recent attention has been on Italy after the December 4 referendum's 'No' vote on constitutional reform cost prime minister Matteo Renzi his job. Problems within the Italian banking system are bubbling to the surface once again, and Monte dei Paschi, the world's oldest bank, finds itself on the brink of default an in need of a bailout.

Those worries have begun to show up in Italy's bond market. While the front end of the curve remains anchored below zero thanks to the ECB's negative deposit rate, yields at the long end have been marching higher as investors sell the bonds. The 10-year has rallied 100 basis points since the middle of August and is holding near its highest level since July 2015. In the wake of Thursday's ECB announcement, the 10-year has tacked on about 15 basis points alone.

While many have been focused on Italy, the action in Portugal's bond market has been more under the radar. Back in October, ratings agency DBRS held its rating for Portuguese bonds at BBB (low), ensuring the ECB would continue to purchase its debt. DBRS remains the only ratings firm that has an investment grade rating for Portugal as all of the others cut theirs to junk following the country's 2011 bailout.

Post-ECB selling has run Portugal's 10-year yield up 35 basis points to 3.81%, which is its highest levels since February as traders zero on what could be Europe's next big problem.

Back in July, Marc Chandler, the global head of currency strategy at Brown Brothers Harriman, noted, "The UK referendum hit an already vulnerable banking system in the eurozone. Italian banks are on the front burner, but the temperature is rising in Portugal."

Additionally, a Barclays team led by Antonio Garcia Pascual observed, "The country is struggling with a systemic banking crisis, the lack of a convincing medium-term fiscal plan and excessive public and private sector leverage." The continued, "This brings into question whether Portugal can address all of these issues without the help of another programme."

And that seems to be the worry. Further aid to Portugal could cause DBRS to cut its rating for Portugal to junk. This in turn would prevent the ECB from being able to buy the country's bonds, and could lead to the next leg of the region's financial crisis.

Indeed, the temperature is rising in Portugal.