S&P put its A-minus long-term debt rating on Portugal on CreditWatch with negative implications, saying a downgrade is possible in the next three months. The move comes as the weaker European economies, known collectively as the PIIGS for Portugal, Italy, Ireland, Greece and Spain, are under attack in the bond markets.

Ireland this week accepted a $113 billion bailout, but that hasn’t quieted the financial markets contagion that now threatens to engulf the Continent in a political crisis.

If anything, this week’s bond swoon has highlighted the ham-handed (sorry) way in which European leaders have approached the PIIGS crisis, in an unhappy replay of the U.S. response to Fannie Mae and Freddie Mac’s funding crisis in mid-2008.

The cost of insuring against a default on Portuguese bonds has surged 27% in two weeks, and the yield spread between Portuguese 10-year bonds and the benchmark German bund surged to 447 basis points, or about 4.5 percentage points. The spread was below 1 percentage point last year and just 3.5 percentage points as recently as September.

S&P said it put Portugal on watch because the government’s efforts to reform its finances fall short of the mark. It cut its 2011 growth forecast for the country and said it may need to accept a bailout, though the government has been claiming otherwise.

In 2011, Portugal’s minority government is set to implement an ambitious fiscal austerity program with an emphasis on reducing expenditures. However, we see the government as having made little progress on any growth-enhancing reforms to offset the fiscal drag from these scheduled 2011 budgetary cuts. In particular, we believe that policies the government has pursued have done little to boost labor flexibility and productivity. As a consequence of the Portuguese economy’s structural rigidities and the volatile external conditions, we project that the economy will contract by at least 2% in 2011 in real terms. The downward revision to our growth projection also reflects the fact that Portugal has not reduced its large external current account deficit during 2010.

If that’s not bad enough, S&P notes Portugal’s hefty borrowings leave it uncomfortably exposed to a run by high-minded Wall Street types.

In addition to what we view as the economy’s weak growth prospects, the large stock of Portuguese debt that non-residents hold (54% of GDP) has increased the government’s vulnerability to rising real interest rates. This contributes to the country’s large gross external financing needs and, we believe, raises the likelihood that Portugal will seek external assistance from the EU.

What’s most worrisome to S&P, though, is a new European Union bailout structure that could eventually expose bondholders to so-called haircuts, meaning they would receive less than full repayment of principal, in the event if a country runs out of money.

“If Portugal does seek an external support program and if we believe private creditors will be subordinated to public creditors, or if Portugal’s fiscal or growth prospects weaken further, we could lower the long- and short-term ratings,” S&P said.

But don’t get S&P wrong, the news isn’t all bad. Yes, the country is already on the verge of being forced into accepting a bailout that will lead to harsher cutbacks at a time of high unemployment, and S&P’s action certainly won’t help Portugal avoid that fate.

Yet here is the time, the rating agency suggests, when we should all be looking at the bright side.

“Even if we were to downgrade Portugal, we would currently expect the ratings to remain in the investment-grade category,” S&P said. Who says it’s too early to feel the holiday spirit?