Mixed signals from Europe: The euro and stocks rally again, but investors stay leery of government bonds

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The euro and most European stock markets on Monday built on their recent rebounds, helped by some upbeat economic data. So that battered foreign-stock fund in your 401(k) plan should be bouncing as well.

But the downgrade of Greece’s government bonds to junk status by Moody’s Investors Service, while not unexpected, was a reminder that the continent’s debt crisis hasn’t gone away.

The euro rose for the fourth session in the last five, rallying to $1.224 in U.S. trading. It had nearly reached the $1.230 level before the Moody’s announcement on Greece, which came after European markets had closed. The currency hit a four-year low of $1.188 one week ago.

European stock markets also continued to revive Monday. The hard-hit Italian market rose 2.7%, bringing its gain over the last four sessions to 8.9%. The German market rose 1.3% and is up 4.4% in four sessions; the Spanish market edged up 0.2%, for a four-day gain of 10.6%.

By contrast, the U.S. Standard & Poor’s 500 index, which was up 0.2% to 1,094 at about 12:30 p.m. PDT after rising as much as 1.3% earlier, has rallied 4.2% from its 2010 closing low reached last Monday.

Given markets’ extreme bearishness about the euro in recent months the currency was overdue for at least a technical bounce, said Sophia Drossos, a currency analyst at Morgan Stanley in New York.

She also noted that “the news flow [about Europe] is starting to get more mixed,” meaning less negative. On Monday the European Union said industrial production in the euro-zone countries in April rose 0.8% from March, a bigger-than-expected increase.

Still, like many analysts Drossos expects the euro to continue sliding in the second half of the year, weighed down in part by debt worries. If the euro reaches $1.25, ‘I think that’s where you sell it,’ she said.

But Moody’s only modestly dented the euro’s rally Monday after cutting Greece’s credit rating to junk status. The country’s grade was slashed four notches, to Ba1 from A3.

Moody’s rival, Standard & Poor’s, had cut Greece to junk in April -- a move that helped to fuel the spring sell-off in European markets.

Moody’s said the European Union and International Monetary Fund agreement last month to lend up to $1 trillion to troubled euro-zone countries over three years “effectively eliminates any near-term risk of a liquidity-driven default” by Greece.

“Nevertheless, the macroeconomic and implementation risks associated with the program are substantial,” the firm said.

Indeed, despite the rally in European stocks in recent days, investors have remained leery of government bonds of financially struggling euro-zone countries, including Spain, Portugal and Ireland. What’s more, markets continue to fear a broader debt crisis as some euro-zone banks struggle to get needed funding.

Spain’s Treasury secretary on Monday admitted publicly that foreign banks have cut off credit to some Spanish banks.

The yield on 10-year Spanish government bonds jumped to a new 2010 high of 4.68%, up from 4.46% on Friday and 4.26% two weeks ago.

“Spain’s challenges are overshadowing Portugal and Greece,” said Marc Chandler, chief currency strategist at Brown Bros. Harriman in New York.

-- Tom Petruno