A new depth of European despair

Confidence in Europe crashed to new lows overnight, as investors realised that the warnings from top European officials are now virtually indistinguishable from the dire predictions of the most pessimistic market bears.

Overnight, Olli Rehn, the European Commission's top economic official, rattled investors with his bleak warning that eurozone no longer had a choice, and that it risked "disintegration” which would lead to a "terrible depression in Europe and around the world” unless it bolstered fiscal discipline and strengthened its crisis-fighting measures.

At the same time, the head of the European Central Bank, Mario Draghi, urged European leaders to introduce a guarantee for all eurozone deposits in order to stop bank runs.

The dark warnings came as investors watched anxiously to see whether Spain, the eurozone's fourth largest economy, will join Greece, Ireland and Portugal in seeking a bailout from the IMF and European Union in order to rescue its ailing banks.

Although Madrid resists the idea, the country is now caught in a vicious trap, with its recession worsening, while its debt levels are rising due to the cost of bank rescues. This week, Madrid's stock market tumbled to the lowest level since April 2003, while country's borrowing costs climbed above 6.5 per cent, perilously close to the 8 per cent level at which Spain, Ireland and Portugal were forced to seek bailouts. Analysts noted that the "spread” between Spanish and German bond yields is now more than 5 percentage points, and that Greece, Ireland and Portugal needed bailouts when their spreads reached a similar level.

With confidence collapsing, investors are piling into assets considered "safe havens”. Yields on US 10-year bonds have now fallen to 1.57 per cent, while yields on 10-year German bunds have fallen to a puny 1.2 per cent, a new record low.

Indeed, the gloom has become so all-pervasive that the grim warnings from ultra-pessimistic analysts are now remarkably similar to the comments uttered by top European officials.

Socit Gnrale's Albert Edwards, who has been a long-term bear, says that investors are about to see their last vestiges of hope brutally crushed.

"As 30-year German bund yields slide below 2 per cent and rapidly converge towards Japanese rates, we have a taster of what is to come in the US and UK in the months ahead. We still see US 10-year yields – even now making new all-time lows – falling below 1 per cent as hard landings occur in China and the US”, he wrote in a recent note.

"The secular equity valuation bear market began in 2000, and renewed global recession will be the trigger to catalyse the third, and hopefully final, gut-wrenching phase of valuation de-rating. Expect the S&P 500 to decline decisively below its March 2009, 666 intraday low. All hope will be crushed.”

According to Edwards, there is still too much "hope” in the markets, which is stopping the equity bear market from reaching its final, devastating conclusion.

"There won't be by the time this is over. Investors will lose all hope, most particularly in their belief that policymakers have any idea what they are doing. We saw the same in Japan.

"As the investors now see the full-frontal naked impotence of their last two supposed saviours, 1) the China growth story and 2) the Fed, there will be savage market retribution.”