The 'Apocalypse Trade'

The European debt crisis is becoming a global credit crunch.

No one should take solace from the fragments of good economic news last week on U.S. employment figures or the enthusiastic response of U.S. consumers to Black Friday retail markdowns.

The painful truth is that Europe and the global economy are still hurtling toward the abyss - even picking up speed. Many maintain that the world is just several weeks away from a much worse crisis and that the situation is very reminiscent of the days leading to the 2008 financial meltdown.

Merkel, Sarkozy, Mario Monti - Reuters- 24.11.11

There are endless numbers pointing to a deepening crisis, almost all of them coming from Europe's debt markets - where a genuine credit crunch began last week.

Italy is now forced to pay higher interest on short-term debt than for 10-year debt - evidence of fear of an immediate crisis. This isn't surprising: Italy must raise 30 billion euros by January for debt repayments and nobody has a clue whether it will succeed - or how.

Belgium's situation is similar. The compact country housing the EU bureaucracy was forced to pay close to 6% interest on two-year and 10-year bond issues. Similar yields led to bailout packages for Greece, Ireland and Portugal.

For weeks Spain, another tottering country, has had to pay this type of interest and is considering requesting international aid shortly, according to one report. Standard & Poor's downgraded Belgium's credit rating one notch to AA over the weekend, warning that the rating could keep dropping if the country's political paralysis persists.

But the most clear-cut proof of Europe reaching a new nadir was the German government's bond issue last week. In what was described as Germany's worst bond sales since the launch of the euro, it tried to sell 6 billion euros of 10-year bonds but sold just 3.9 billion euros, at a 2% yield.

This may be a very low yield but it's still higher than 10-year paper issued by the United States, Britain and Scandinavian countries. It points to a much greater problem: Investors are simply fleeing anything smelling of Europe - including mighty Germany. Abstinence from German bonds almost immediately earned the sobriquet the "apocalypse trade."

If even the German government's debt is having trouble luring investors, could this be a clear sign for the end of the euro? Indeed, last Wednesday the European currency lost no less than 2% against the dollar - still short of a catastrophe, but definitely a hastening of the retreat from the continent.

Paul Krugman, a Nobel Prize winner in economics and New York Times columnist, wrote on Thursday: "I really wasn't planning on blogging on Thanksgiving Day. But what's going on in Europe deserves a mention." He was referring to the 2.2% interest rates on German bunds, above the 2.17% U.K. bond rates and 1.88% U.S. rates.

"The way to see this is that the market is in effect pricing in a real possibility of eurozone collapse," wrote Krugman. "In particular, market expectations seem to assume that the European Central Bank will remain utterly indifferent to its responsibilities. The German breakeven rate, an implicit forecast of inflation over the next 5 years, is just 1 percent. That's a disaster level, implying severe deflation in the debtor nations - or, more likely, a euro breakup. Awesome all around."

There are further indicators of a credit crunch. European banks are afraid to lend money to each other. The Libor-OIS (overnight indexed swap ) spread, reflecting the gap between rates the banks charge each other and market expectations, rose to 0.41%, its highest level in two years. This is still a far cry from its 3.5% peak in October 2008, but the trend is clear. And there's the drop in Asian currencies and one of the toughest weeks for stock markets, with the Dow Jones Industrial Average sinking 4.9% and the Tel Aviv Stock Exchange benchmark TA-25 index tumbling 7.8%.

Over the weekend the markets entered a new and even more worrying phase, with investors fleeing anything connected with Europe or any financial risk at all. No one has any doubts that the crisis in Europe will lead to a worldwide slowdown. Money is being transferred into a handful of investment channels thought right now to be a bit safer, like bonds from the United States and countries without debt, and traditional safe-haven currencies like the dollar.

The financial apocalypse may not have arrived yet, but the markets' warning lights are flashing like crazy and financial nerves are on edge. This type of situation promises to provoke very heavy market volatility - in Israel too - and desperate activity by Europe's politicians to find ways to tranquilize the markets and cure the economy. Considering their performance over the last year - and more so the depth of fundamental flaws - it's doubtful they will succeed.