Political turmoil is rearing its ugly head in the euro zone again, but this time it's making an appearance in Portugal!

At the start of the week, we were greeted by news that Vitor Gaspar, the brains behind Portugal's 75 billion EUR bailout plan, resigned from his post as the country's finance minister. Gaspar announced his decision in style - he wrote a strongly-worded letter in which he slammed those who had opposed his bailout program.

The following day, we received word that Paulo Portas, the foreign minister and leader of the center-right party in the coalition government, followed in Gaspar's footsteps and stepped down as well.

But the surprises didn't end there. Upon hearing that another official had resigned, the prime minister, Pedro Passos Coelho, told Portas, "You ain't going nowhere!" and rejected his resignation. Coelho added that he won't give up on his country and that he wants to talk to leaders of the junior party to sort things out before things get out of hand and the country is forced to hold early elections.

As though the current political conflict in Portugal isn't bad enough for euro zone's fundamentals, it also places the country's bailout in jeopardy.

In a couple of weeks, the Troika, which is composed of the IMF, the European Central Bank, and the European Commission, will check on Portugal to see how well the country has been handling its bailout and if it can meet its obligations. Keep in mind that the IMF already made an assessment of Portugal's ability to meet its bailout conditions last month, and it didn't quite pass with flying colors - in fact, it was described as "fragile."

With the country under political turmoil and the main proponent of their austerity program gone, investors fear that Portugal might not have much leverage against the Troika and have a hard time at the negotiation table.

Clearly, the country is faced with quite a bit of uncertainty at the moment. José Manuel Barroso, the European Commission president, believes that Portugal's two years of hard work and belt-tightening could go to waste if this issue isn't resolved smoothly. Furthermore, people don't have much faith in the current government, which is why many have been calling for early elections.

Portugal's risk of losing its bailout package revived fears of a sovereign default, as market analysts remarked that the combination of political uncertainty and rising bond yields is a double-whammy for the country's fiscal standing. Bond yields in Portugal already spiked to 8% for the first time since November and could continue to climb if the situation gets more complicated. This would fuel more doubts regarding Portugal's ability to fund its debt.

Recall that the IMF already highlighted Portugal's "fragile" ability to meet the terms of its current rescue package, pointing to the difficulties faced by the coalition government in pushing for spending cuts and reforms in the labor market. Germany, which is the largest creditor under the rescue package, reminded the Troika to be extra strict in imposing the bailout terms.

This dashes Portugal's hopes of returning to the money markets next year to secure more funding for its government debt. If Passos Coelho refuses to step down, more political uncertainty could be in the cards and nationwide protests could escalate. Protesters are calling out for an early elections to replace the current ruling party, and this appears to be the better alternative for Portugal right now.

For now, while the political scene is wrought with uncertainty, the euro could be under heavy selling pressure as markets price in the possibility of Portugal losing its bailout and giving in to default.

Source http://www.fxstreet.com/fundamental/analysis-reports/piponomics/2013-07-04.html

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