Cyprus has it's bailout as Laiki Bank is split ... some pay a heavy price!

Week commencing Monday 25th March 2013

Overriding Market Themes

European finance ministers have finally agreed a deal to bail out indebted Cyprus, preventing its banking system collapsing and securing the countries future in the Eurozone. The 10 billion Euro package will guarantee all deposits under 100,000 Euro placed within the Laiki Banking Group, however individuals with more than that will face larger than projected haircuts on their savings as the government winds down the organisation.  Laiki will be split into "good" and "bad" banks, with its good assets eventually merged into Bank of Cyprus. The deal came after hours of tense negotiations between Cypriot President Nicos Anastasiades and the "troika" of EU, European Central Bank and IMF leaders, who threatened to resign if a deal could not be reached. The markets have welcomed the news, mostly as it now removed uncertainty from the Eurozone equation, reducing the risk of contagion to other peripheral European counties. The euro rose unsurprisingly gained this morning as a result, rising 0.3 percent to $1.3033 at 3:40 a.m. London time. Stocks also gained, with futures on the Standard & Poor’s 500 Index adding 0.5 percent and the MSCI Asia Pacific Index climbing 1 percent. 


Back closer to home, the UK moved a step closer to losing its top AAA credit rating at Fitch Ratings after the Chancellor said debt will rise more than previously forecast. The UK was placed on rating watch negative, which according to Fitch indicated a “heightened probability of a downgrade in the near term,”. This comes in the wake of last week’s budget, in which the chancellor slashed growth forecasts in half. This was confirmed by the OBR, who cut its growth forecast to 0.6% for 2013 from its 1.2% figure it forecast in December. Interestingly, it appears that it is only the government who are worried about a potential downgrade, as investors for the most part appear to be ignoring it, as has been evident by the drop in gilt yields since Moody’s downgrade. Interestingly, Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades and changes in credit outlook last year, according to a Bloomberg study. The pound cut its advance against the dollar after the Fitch statement. It was trading at 1.5173 at the close of play last week, up 0.3 percent from yesterday.


In some welcome good news for the UK, Retail Sales rose by 201% in February compared to January’s reading, where bad weather was blamed for keeping sales low. The Office for National Statistics saw technology and computers, and goods bought online as the main driver for the bounce back. It seems that sales were strong more on the back of lower prices than a push in consumer demand, and with a smaller than usual price increasing in areas like food and clothing, people tend to spend more. The big question is whether this surprise jump in Retail Sales is enough to pull the UK out of the prospect of a triple dip. Unfortunately I think this is unlikely, as fundamental structural weakness in the Eurozone coupled with a decline in UK government spending leave little room for the private sector to fill to gap, in the near term. 

GBP This Week

The good old Pound enjoyed another strong week, gaining over one cent against the US dollar reaching a high of 1.5229. There are nine releases in the upcoming week, of which we will be watching three. The highlight is surely the Current Account, due out on Wednesday. This is a key release for us, as a stronger reading indicates that foreigners are purchasing more British goods and services with Sterling. The February reading saw a sharp reduction in the Current Account Deficit, which fell to 12.8 billion pounds. This beat the estimate of 14.1 billion pounds. The March forecast calls for a modest drop in the deficit at 12.4 billion pounds, which should give Sterling some support. Next on our agenda is Chancellor George Osborne’s testimony to the Treasury Select Committee. We export some hawkish statements from George this time round, and are widely expect to be bullish for the pound. Finally, we are watching the Final GDP release on Wednesday. This is released each quarter, and previously jumped 0.9% in Q4, its sharpest increase since 2010. The markets are bracing for a much lower reading in March, which is estimated at -0.3%. Despite always trying to be positive on the UK and its economy, I cannot see how this figure could get into positive territory with the UK economy under such pressure both domestically and internationally, so I expect this to be a pound negative release. 


Let’s be fair, the Pound has enjoyed another strong week, but fundamentally let us not forget the huge declines it has suffered against both the Euro and the Dollar since the beginning of the year. When compared against the US, the UK continues to look weak whilst a strong US economy continues to lead the G8 into recovery. Given the sharp contrast in the prospects for the two economies, the Pound will have a tough time making more gains against the dollar. The Pound should have an easier time against the Euro, however with the close tethering between the UK and EZ economies, we expect to see GBP/EUR remain within a 2 cent range.

USD This Week

The Dollar saw some marginal declines last week as the crisis in Cyprus didn’t turn into the general risk off environment many expected. Foreign Exchange dynamics have therefore clearly changed, and it is testament to the dynamics of the Eurozone that Cyprus didn’t cause serious damage to the currency. Important events such as, Ben Bernanke’s speech, US Durable Goods Orders, Consumer confidence and more housing data are among the major market movers this week for the Dollar. Monday sees Federal Reserve Chairman Ben Bernanke speaking in London with the BOE Governor Mervyn King.  Ben Bernanke supports the continuation of the stimulus plan, despite the recent flow of positive data released, claiming the US economy is still in need of incentives to bolster growth. We hope he further explains his point during the meeting. Moving to Tuesday, we expect Durable Goods Core Orders to climb by 0.7% this month after last month’s huge decline after a sharp drop for civilian and defence aircraft. Also, we expect a small drop in US Consumer Confidence after February’s jump from 58.6 to 69.6. Consumers appeared to be relieved after the shock effect caused by the fiscal cliff uncertainty and payroll tax cuts dissipated, but as with most rallies, a claw back is expected to 69.3. Finally, we expect a decline in both US New Home Sales and Pending Home Sales as a dwindling housing inventory and a decrease in the rate of new housing supply cause an increase in house price inflation. 


The Dollar’s recent weakness is in no way indicative of a weakened US economy, and as such as soon as markets regularize we expect the Dollar to continue to strengthen against most majors. Indeed, as the Cypriot banking system returns to some element of normality we could see some capital flight into the Dollar, and so we switch our USD outlook from Neutral to Positive. 

EUR This Week

EUR/USD was trading under a lot of pressure as the crisis in Cyprus dominated the news last week.. In addition to this story, which although mostly resolved continues to effect market sentiment, we have German retail sales and unemployment to concentrate on. German retail sales have seen strong gains of late after a major contraction in December, and it seems this month should be no exception. Consumer sentiment supports economists’ forecast that the German economy will expand in the first quarter of 2013, and coupled with this, we expect a small rise in Retail Sales of 0.4%. We then move to German Unemployment Change, which saw a fall last month of 3,000 against a market estimate of 5,000. Interestingly, these drops mean that the unemployment rate remains steady at 6.9%, just above 6.8% which is the lowest point since the country was reunified in 1990. This indicates a strong labour force and business confidence in the EZ’s largest economy, and we see no reason for that to change, and are therefore forecasting a continued decline in the number of unemployed by 2,000 this month.


The crisis in Cyprus has damaged a European image which for the most part was on the mend. Despite the agreement in hand, we still could see money flood out of the country when banks open. We believe that a relief rally, if any, will have a limited impact on EUR bulls. Moving the crisis to one side, the economic situation remains weak, as recent figures have shown. This is different from the US, where most economic indicators point to a somewhat accelerated growth.

In Other News

England face a humiliating series defeat after slumping to 90-4 on the fourth day of the third and final Test against New Zealand in Auckland. The tourists lost Captain Alastair Cook for 43 and night-watchman Steven Finn to poor shots in the closing stages. England was set a whopping target of 481 to win in just 143 overs. Just in case that was not enough for people to swallow over the weekend, thousands of homes are still without power as snow and bad weather swept through our islands. In Scotland several thousand homes were affected after power cables were torn down, whilst in Northern Island some remote villages face days before any rescue can be made. And here I thought our cricketers had it bad!


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