NEW YORK ( TheStreet) -- Italy has become the new focus of euro skeptics as pessimism over Europe grows.

Many investors were focused on the Spanish housing and banking situation, expecting it would be the source of financial turbulence for the currency union, when Greece stepped into the picture and seized global attention.

Over the course of a month, the euro fell from $1.45 to $1.35, but the decline has slowed recently. Greece has until March 16 to come up with a plan to cut its deficit, and this has calmed the markets for the moment.

However, the pause in activity didn't turn attention back to Spain; instead, investors have taken a deeper look at Italy. At the national level, and similar to Greece, Italy used currency swaps to help it enter into the common currency. Although Italy is not in the same fiscal situation as Greece, the parallel is still a disconcerting one.

Italy's municipal governments also used derivatives. Earlier this month, the Italian government seized assets of Bank of America ( BAC) and Dexia SA as part of an investigation into derivatives contracts within one municipality.

All told, 519 municipalities have used derivatives contracts that have resulted in nearly a billion euros in losses. The amount isn't the concern here, but rather the widespread use of derivatives, which for obvious reasons carry a negative connotation with investors.

On top of these concerns, this weekend, Columbia economics professor Robert Mundell, widely credited as laying the intellectual groundwork for the creation of a common currency, said Italy is the greatest threat to the euro. Italy has about 25% of eurozone debt, several times larger than Greece's share, and a crisis there would be several times larger than the crisis in Greece.

Together, these stories show that Italy is gaining attention in a way that it hadn't before. It was lumped together with other troubled counties via the PIGS acronym, but Italy was in the shadow of Greece, Spain and Portugal because Italy's situation isn't as bleak. The country's budget deficit is not far out of the bounds of the Maastricht Treaty, which limits annual deficits to 3%, and no one is looking for a sovereign default or a banking crisis.

Although Italy has mostly stayed out of the headlines, investors have been punishing the iShares MSCI Italy ( EWI) ETF. Over the past three months, EWI is the second worst performing Europe ETF, ahead of only iShares MSCI Spain ( EWP). In terms of long-term momentum, EWI is one of the weakest international country ETFs.

Going forward, EWI and EWP will be the most volatile European country ETFs in the near term. They are under pressure due to Greece's problems and should Greece fall, one or the other will become the next nation at the center of global attention, with a weaker euro dragging returns on all European assets.

On the flip side, some of this pressure is already priced into these ETFs. A positive outcome for Greece would be most bullish for EWI and EWP because negativity is already priced into shares. Over the past three months, for instance, the losses in EWI and EWP are about double those of iShares MSCI Belgium ( EWK) (EWK).

More broadly speaking, if Italy adds increasing weight to the worries of investors, it will add more selling pressure to the euro, which will drag on the returns of all ETFs holding assets priced in euros.

-- Written by Don Dion in Williamstown, Mass.
At the time of publication, Dion does not have positions in any of the equities mentioned.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.

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