Remember pesky old Europe? That debt-ridden continent on the other side of the Atlantic?
Yes, the Europe that has sent global financial markets reeling time and again since 2008.
You may not. With stocks at record highs and the U.S. economy improving, the European debt crisis seems like a distant memory. Investors have been far more concerned with domestic issues such as Bernanke’s posturing, rising interest rates, and the unwinding of QE3.
Europe is no longer the market’s focal point. But that doesn’t mean the euro zone’s financial problems have gone away.
Portugal is the latest evidence of that. And it’s a story that the American financial media have largely ignored.
Portuguese bond yields spiked to 8% last week amid rumblings that the country will need a second bailout. Turmoil among Portugal’s three main political parties has fueled fears that the country may not be able to satisfy terms of its current $102 billion bailout from 2011. It was the latest reminder that even though Europe is no longer in the spotlight, its debt problems haven’t disappeared.
In addition to Portugal’s problems, here’s what’s happening in four of Europe’s largest economies:
The Latest: Fitch downgraded France’s credit rating to AA+ from AAA last week, citing forecasts of even higher indebtedness.
The Latest: The mayor of Athens was assaulted by workers protesting the country’s recent austerity measures. Greece recently 15,000 civil service jobs and reduced wages for thousands of others even as the country approaches a 30% unemployment rate.
The Latest: Standard & Poor’s downgraded Italy’s credit rating to BBB on July 9 as the country’s economic prospects grew even weaker. It might not stop there – the firm said another downgrade could be coming later this year or early next year. Fears of a bailout are starting to grow.
The Latest: Yields on 10-year Spanish bonds surged to their highest level in 11 months due to lack of demand at an auction of 4 billion euros of debt.
To date, international creditors have already granted more than $257 billion in financial assistance to indebted euro-zone countries. Now Portugal is hanging on by a thread as support for the current three-year austerity program wanes.
Portugal’s jobless rate has risen to 17.6% after two years of spending cuts. That’s better than Greece or Spain, but still far above “healthy” levels.
The country’s austerity measures are working. Portugal’s fiscal deficit has fallen to 6.4% from 10.1% in 2010. But with thousands of workers losing their jobs, the country’s Socialist Party wants to put an end to austerity – which would be a violation of the current bailout agreement. Should that happen, Portugal could plunge even deeper into recession and become the second country (along with Greece) to request a second bailout.
All of these problems have a domino effect. We’ve seen before that European debt problems spread like wildfire. Every time one country’s debt problems worsen, it impacts several others. And the worse Europe’s debt problems get, the more exposed U.S. banks and other businesses become to the contagion.
We experienced this in 2011. Europe’s problems were splashed across the cover of every financial newspaper on a daily basis that year. As a result, volatility reigned. The S&P 500 was flat for the year – only the second time since 2002 the index failed to rise. At the time, it seemed like Europe’s problems might hold U.S. markets hostage until the euro zone’s debt problems were resolved.
We know now that didn’t happen. Fortunately, U.S. investors turned their attention to a declining employment rate, record earnings and an improving housing market. In the meantime, stocks have risen 31%.
Let’s hope the data continues to improve. Growth at home is a good distraction from the turmoil in Europe.
Should that growth slow, however, investors may again turn their attention to Europe.
If they do, they won’t like what they see.