By Evaldo Albuquerque, editor, Exotic FX Alert
Imagine getting a letter from your bank saying your mortgage bills will double starting next month.
If you were paying $1,200 a month, you’re now responsible for a $2,400 payment. And there’s nothing you can do about it.
It’s not far-fetched. It already happened to thousands of Americans, just a few years ago.
During the real estate boom, adjustable-rate loan companies suckered in Americans with their very low teaser rates.
House prices back then were so high that many people could only afford to buy a home with this kind of loan. The initial low rates made the monthly payments very affordable.
But things got very ugly once those loans reset to higher rates. Mortgages bills skyrocketed, and forced many Americans to give up their homes through foreclosure.
Now, something very similar is happening in Europe. But it’s not happening in the housing sector.
This time, governments are the ones facing skyrocketing interest payments. And there’s one more EU country that’s doomed to face a “rate reset.”
When it does, it will send the euro spiraling even lower. Let me explain…
Why 7 Is the Point of No Return for the EU
Recent events have proven that the European troubled nations (affectionately known as the “PIIGS”) can’t handle interest rates above 7%.
What that means is, these nations can’t afford to pay bond rates above 7%. When the yields on 10-year sovereign bonds cross that level, it’s nearly certain that a country will ask for a bailout.
In other words, when bond rates hit 7%, these countries cry “uncle!”
That number has already exposed the true extent of Greece’s and Ireland’s problems. Once Greece’s debt holders started demanding an interest rate above 7%, it took Greece 16 days to ask for a bailout. Ireland requested a bailout 20 days after Irish debt hit the magic 7% level.
Those countries just couldn’t afford such high borrowing costs. It’s just like what happened during the U.S. real estate crisis – only on a grander scale. Eventually, the mortgages rise to a rate that Americans simply can’t afford to pay – and they foreclose.
Well in sovereign debt, nations ask for a bailout once their debt hits 7% rather than “foreclose.”
And now, the dreaded 7% interest rate is about to make another victim: Portugal.
It has just breached that important threshold. Check out the chart below. It shows the yield on 10 years bonds from troubled European nations.
Portugal Can’t Afford Such High Borrowing Costs
Portugal: The Next Shoe to Drop
Portugal’s borrowing cost is approaching dangerous levels. Some European Union member states are increasingly concerned about Portugal’s ability to fund itself in financial markets. With interest rates on the rise, Portugal is not going to be able to hold on beyond the end of March.
Meanwhile, investors are demanding a higher interest payment on Portugal’s bonds because of uncertainty regarding the rescue fund.
European authorities promised to announce a comprehensive plan to solve the debt crisis by March. But there are a lot of disagreements between Germany and troubled nations, such as Greece and Italy.
Germany is proposing tougher austerity measures in exchange for beefing up the rescue fund. But Greece and Italy have already rejected Germany’s proposal.
So there’s a good chance European authorities won’t keep their promise of delivering a final solution by the end of next month. When that happens, Portugal will be in trouble.
Mark This Date on Your Calendar
Athanasios Orphanides, one of the European Central Bank members, has recently warned that without a comprehensive plan, European nations might slip back into crisis.
In his opinion, the longer political leaders “delay in agreeing on a framework that will ensure stability, the greater the threat of another crisis similar to what happened in 2010.”
All the European Union nations will be meeting at a summit at the end of next month. March 25 is the informal deadline for the leaders to announce a comprehensive package of measures to address the sovereign debt crisis in Europe. If they fail to announce anything significant, the market will get very upset.
Orphanides’ fears will become reality, and the euro will take a dive. So make sure you mark this date on your calendar.
In the meantime, I’m shorting the euro with everything I’ve got. I recommend you do the same.
Editor, Exotic FX Alert