In 1999, 11 European countries surrendered their
currencies for the euro and a shared monetary authority. Barely a
decade later, the once-celebrated EU is in the midst of a credit crisis
and its currency is facing collapse.
Elliott Wave International's analysts have been
anticipating and tracking the credit contagion across the European
nations for the past two years. EWI subscribers were first alerted to
the still-developing European debt crisis back in December 2009.
The Credit Crisis Spreads -- December 2010
The credit crisis is escalating as expected. Back in January 2010, when
ratings agency Moody's bestowed "investment grade" status on a widely
followed index of sovereign bonds, The European Financial Forecast
argued that a renewed Primary-degree decline would in fact aim the
credit crisis directly at this critical new realm. Our case for the
looming sovereign debt debacle rested primarily on two pieces of
evidence: (1) Primary wave 3 (circled) had begun in Europe's peripheral
markets, and (2) premiums for credit-default swaps on European
sovereigns (think of an insurance policy against a national default)
were already signaling the next phase of the crisis by surpassing their
2008-09 price extremes. The February 2010 issue of EFF published a
chart showing rising Greek, Spanish and Italian swaps and offered this
description of how Europe's credit crunch would escalate: "The theme
during Primary wave 1 (circled) was default at the individual,
corporate and quasi-government level. The theme for Primary wave 3
(circled) will be default at the sovereign level."
Today, the credit crunch is clearly angling itself
away from mere corporations and toward whole countries. On November 15,
Bloomberg announced the escalation with this headline:
Companies Safer Than Sovereigns as
Crisis Cracks 'Old Order'
-- Bloomberg, November 15, 2010
London credit strategist Greg Venizelos tells
Bloomberg that the "old order" was the one where investors believed
large sovereign nations to be better credit risks than corporate
borrowers. However, debt is being repriced, he says, and today
"corporates are now better credit quality than sovereigns in the
periphery." Indeed, swaps on Italian government bonds are more
expensive than 75% of the Italian companies contained in the iTraxx
Europe Index of European corporations. In Spain, traders deem Spanish
sovereign debt to be riskier than all six Spanish companies in the
index. Even in the supposedly safe core European country of France,
5-year swaps tied to French government bonds climbed to an all-time
high of 105 basis points in November. At that level, more than half of
the 25 French companies in the iTraxx index trade tighter than the
French sovereign, according to Bloomberg.
The chart above shows another way to view the
escalation of the credit crisis. By plotting the difference, or
"spread," between swaps on European corporations versus those on
European sovereigns, the rising line shows derivative traders'
increasing fear over sovereign default relative to corporate borrowers.
So, yes, the old order of safer sovereigns is over. But notice, too,
that the debt crisis began escalating when the continent's peripheral
markets started topping way back in October 2009. The billion-euro
question is, "Who is next?" The media is clearly focusing on Portugal,
as 5-year credit default swaps tied to Portuguese bonds are setting
all-time records. But charts show that so too are swaps tied to Spanish
and Italian bonds. Five-year swaps on Belgian debt also reached an
all-time high last month. Either one of these countries could be next.
Maybe they'll all go down together, but in the larger scheme of things,
it doesn't matter. The most important thing to observe is that even
core European countries like France and Germany exhibit spiking default
insurance premiums, too. These countries are the largest contributors
to the �440 billion Facility, the same one that backstops the rest of
Europe.
The June 2010 European Financial Forecast
said unequivocally that before the storm is over, "at least one, but
more likely several, G8 nations will capsize." We stand by our forecast.
