U.S. stock exchange traded funds were set to follow European markets lower Wednesday after China again raised interest rates in an effort to cool inflation, while a downgrade of Portugal’s debt rating to “junk” by Moody’s stoked credit worries.

SPDR S&P 500 ETF (NYSEArca: SPY) was down 0.4% before the bell. The $7.2 billion iShares FTSE China 25 Index Fund (NYSEArca: FXI) slipped nearly 2% after the People’s Bank of China announced its third interest-rate hike this year.

Moody’s on Tuesday warned that there is a gap in public finances likely to damage Chinese banks. Simon Rabinovitch for Financial Times reports that an understated debt of $541 billion was discovered, and this pushes up the ratio of bad debt anywhere from 8% to 12%, and higher than anticipated last year. [Gold and Silver ETFs Rally as Moody’s Warns on China and Portugal.]

“We conclude that the potential scale of problem loans at Chinese banks may be closer to our stress case than our base case. This is clearly a negative trend for creditors,” said Yvonne Zhang, one of the authors of the Moody’s report.

In Europe, the Portugal downgrade quickly brought the region’s debt woes back into focus after last week’s austerity vote in Greece. With a negative outlook, the rating was cut from Baa1 to Ba2 by Moody’s, report David Jolly and Liz Alderman for The New York Times. More downgrades could follow, Moody’s warned. [Financial ETFs Hit on Bank Exposure to Greek Debt Crisis.]

Yields on Portuguese bonds surged on Wednesday.

“The only saving grace for Portugal … is that it’s much smaller than Greece. But that ratings downgrade reminds markets that it’s not just Greece with debt issues. Once Greece gets wrapped up, you move on to the next country, and in all likelihood that will be the shape of things to come over the next year or two in the Eurozone until the long-term financing trajectory for these countries gets stabilized,” Robert Tipp, a Prudential strategist, told Reuters.

Although Portugal received a $116 billion rescue package in May, Moody’s anticipates the country will need another bailout until funds could be raised for the bond market. The private sector in Portugal, particularly lending, will take a subsequent hit as well, the ratings agency said.

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