by Cliff Wachtel, Global Markets
First, let’s start with a quick review of what moved markets each day last week.
Cyprosis: Deterioration of Cyprus caused by hardening of cash arteries that supply it.
Monday: Cyprus bailout deal implications send all regions lower
That’s it. Nothing else mattered. Indexes in all three regions, Asia, Europe, and the Americas were all lower on the latest EU scare, this time emanating out of Cyprus. The problem was that the EU made its a €10B bailout conditional on Cyprus ending its role as an offshore tax evasion haven and demanded that it tax bank deposits or leave the EZ. The Cypriot parliament, seeking to keep that business alive, chose to tax even small deposits in order to avoid hitting the big ones too hard and killing their money laundering business.
The thing that scared markets about the deal was that it broke an unspoken but assumed rule that EU bank deposits would be safe up to at least the insured €100k limit. That risked sparking a run on the banks of other peripheral EZ economies as depositors would realize they too could be subject to a similar “one time” hit. Why keep money in Spain or Italy when you can keep it in Germany or some other more stable domicile?
Such a wide scale bank run would again put the solvency of peripheral banking systems of Spain, Italy, Greece, etc. in doubt. Indeed the mere risk of that happening could become self fulfilling.
Therefore the EU clearly had to get a bailout in place before confidence in these banking systems buckled. The stakes were high, setting off a burst of dire warnings (for example). Balancing these worries, both on Monday and the rest of the week, was the belief that once again a solution would come that at least would defer the problem long enough for a tradable move higher. While Asian indexes fell hard 1.5-2.5%, the moves lower for Europe and the US were far more restrained. Is it crisis fatigue or just long experience with this kind of thing?
Tuesday: Moving On Cyprus Speculation Again
Asia enjoys technical bounce as bargain hunter swoop in after seeing European and US markets drop much less (about 0.5% in Europe, less in the US) than Asian markets (1.5 -2.7%) on Monday. That more subdued Western reaction fed the assumption that Cyprus fear will be contained
European indexes dropped harder, Germany down 0.78%, France 1.3%, and Spain 2.2%, on expectations that the Cyprus Parliament would reject the bailout deal as unfair, and suicidal from both a political perspective (given its blatant unfairness) and possibly physical perspective too (given the reputed large presence of Russian Mafia money in Cyprus banks, depositor reaction might not be limited to violent protests).
US indexes closed slightly lower as they continued treating Europe’s latest attack of “Cyprosis” as just the usual EU BS, contagion threat, deferred by more lending of printed money to the insolvent, a tradable rally as markets focus on the short term bounce rather than the now worse ultimate day of reckoning. The new loans to those who can’t pay mean an ultimately bigger default, or a more extensive printing of Euros and risk to that currency’s purchasing power.
Wednesday: US Fed’s FOMC Grabs The Attention, But FedEx The Big Headline
All regions’ indexes closed mostly higher on continued bounce after Monday’s big drop as fears about Cyprus eased on the assumption that a solution was coming given the relatively small bailout needed and the potential contagion risk from decreased GIIPS banks depositor confidence.
With no new developments likely for at least a day or so, focus shifted to the US and the Fed’s FOMC announcement, which could have been market moving if there had been any surprises. As expected, however, the Fed announced no changes to current policy despite improving US data. Overall that was obviously a positive for stocks and other risk assets, as improving US data brings increasing likelihood that he’ll announce plans to reduce stimulus in the coming months. That could remove the one real prop to the current rally.
Arguably the most important news of the day was that a major corporate barometer for the health of the global economy, FedEx, announced disappointing earnings, and cut its guidance. This suggests that the ongoing story of slowing global growth continues with just a few isolated exceptions like the US and Germany, though neither look robust, and of course China if you happen to actually believe it makes even a good faith attempt at honest economic data.
Thursday: Data The Main Market Mover
Asian indexes were mixed with modest moves up or down but Japan was again up strongly on optimism about new easing to be announced in early April by the new incoming BoJ Governor Kuroda. Bernanke’s continuation of full QE 3 also didn’t hurt. Once again they ignored Cyprus risks as no news was taken to be good news. A good Chinese PMI report helped lift Shanghai and shares connected to it.
European and US indexes however, closed solidly lower, well over 0.5%, pressured by poor German and EZ PMI figures, and the ECB’s deadline for a Cyprus bailout deal. The positive China PMI data, as well as news of continued full QE 3 moderated the pullback.
The ECB gave Cyprus until Monday to agree on a bailout or face losing the current flow of the ECB’s ELA emergency funds for Cyprus banks, which remain closed but are offering limited ATM service. However it’s unclear whether the ECB can do this without a 66% majority vote in its Governing Council, nor that such a majority exists.
Perhaps the ever-present temptation to take profits with markets at decade highs was also a factor in the pullback, given these two news items.
Friday: Markets Mixed With Mostly Modest Moves Up Or Down On Guarded Optimism For A Cyprus Deal
Asia closed mixed, mostly modestly lower (under 0.5%) but Japan’s Nikkei plunged 2.35% on a combination of Cyprus jitters and high prices that brought profit taking. Barring any new stimulus announcements, which are not expected until the first BoJ meeting under its new Governor Kuroda, Asia is moving on Cyprus headlines, like the rest of global markets.
European indexes closed the week mixed, mostly modestly lower on guarded optimism for a last minute Cyprus deal that doesn’t damage confidence enough to derail the ongoing rally
US markets all closed solidly higher, around 0.7% on greater optimism for a Cyprus deal that doesn’t damage the ongoing risk asset rally.
Five things changed in the EU last week, three things didn’t. Here’s a quick overview of those and other lessons from last week.
WHAT CHANGED LAST WEEK FOR THE EU
Here’s a brief overview of what changed for the EU last week.
1. A Further Blow to Confidence – or Complacency
“Toto, I’ve a feeling we’re not in Kansas anymore.”
From the 1939 film The Wizard of Oz
If there was still any doubt, it should be clear the EU is still no US when it comes to stability of its currency union, and by implication, its currency. The US has its problems, but as a currency union it has no imminent existential threats. Not so for the EU.
Over the past years a number of assumed EZ promises have fallen, all of them along the theme that the EZ was an improved version of the US: big, diversified economy with similar economies of scale and freedom of movement for capital and labor, investor friendly, with the added benefit of having the more hard money Germans at the helm insuring that the EUR would retain its value better than the USD.
- EU Regulations To Insure Responsible Economic Policy Would Be Followed And Enforced. There were conservative maximum allowed debt/gdp ratios, etc. Everyone would follow them and if not these rules would be enforced.
- The EUR Was A Hard Money Currency: The Germans would never allow money printing or other policies that would endanger the EUR’s so that the EUR would retain its reputation as a modern day version of the uber-hard money DM.
- The EU Banking System Was As Stable As That Of The US: Ultimately the EU would ensure banking system stability, despite the lack of integration and potentially divisive differences in policy.
These assumptions had the EURUSD as high as ~1.51 in late 2009 months before the first Greek crisis and nearly that high again in the spring of 2011 before the second Greek crisis.
They were all either gone or in extreme doubt long before last week.
2-3. More Promises Broken: Deposit Safety – Only As Safe As Their Sovereign Host
Last week another two assumptions fell.
- No Sovereign Defaults
Until last week this one looked shaky but at least had never actually happened. Even Greece was still in the EZ, despite repeatedly failing to meet its bailout agreements. However last week, for the first time, EZ member Cyprus was explicitly threatened with expulsion unless it accepted EU terms for a roughly 10 bln euro bank bailout.
- The European banking system was stable because the EU would stand behind all EU banks.
It went without saying that the above included that bank deposits were absolutely safe up to their insured amount, just like that of the FDIC in the US. We won’t know the exact details of the final Cyprus bank bailout until early this week at best. However it’s clear that most of the deposits and depositors will face some kind of expropriation, regardless of what it is called. The latest report as of this writing is that Troika officials have accepted a 20% of all deposits over 100k Euros.
The only question now is how exposed are depositors in other at risk nations?
Optimists claim that Cyprus is likely to be a one off case because:
- It is so small that it presents little contagion threat (0.2% of EZ GDP vs. Greece’s 2% of EZ GDP). Markets were relatively steady last week, so they clearly did not see Cyprus as a contagion threat.
- It was less deserving of support because its banks were a known money laundering center for tax evaders
- Coming German elections in September mean that German officials need to show they are defending their voters’ interests and minimizing further German handouts.
- That which can’t be repaid won’t: Cyprus is a sign of things to come. We’ve already seen Greek bond holders forced to take “voluntary” losses. Now depositors are on the menu. Other insolvent sovereigns will eventually have no choice but to do the same, given that the GIIPS economies are getting worse, not better.
- Voter opposition in Northern funding nations like Germany to endless transfers of their taxes will not only continue but grow.
For now, it’s reasonable to conclude that deposits are only as safe as the state that backs them. Or perhaps, as safe as the contagion threat their nation’s collapse would present?
4. EU More Prone to Bank Runs, Capital Flight
That means GIIPS nations’ deposits are less secure. Greece and Spain have already seen capital flight. The ECB’s OMT may have slowed that trend by improving confidence in these nations’ banks. No more. Expect that trend of capital flight to accelerate and spread to other GIIPS nations.
As was repeatedly mentioned last week (see here for one example), the Cyprus precedent could mean that those deposits that haven’t yet fled for safer domiciles will be quicker to do so with less provocation than in the past.
5. Rising Costs for EU Banks Ahead
If deposits are only as safe has the state that backs them, then EU nation banks are now riskier places to leave money, and so can expect to pay for both depositor funds other loans. This is particularly true for the GIIPS nation banks, especially the weakest and most vulnerable to EU pressure. The most stable nations may see no real increase in borrowing or depositor costs. They may even see a decrease if
WHAT DIDN’T CHANGE: All The Big Issues
The above are ominous changes, but they’re still just symptoms of the same problems that never went away, despite the calm of the past months due to:
- OMT and other programs that essentially promised to keep cash flowing to otherwise insolvent banks and nations.
- Elections In US, Japan, and their ramifications for these economies.
None of the EU’s fundamental problems have been fixed.
1. Deteriorating Economy
Overall the EU is contracting. See here for details of recent data
2. Choices Not Made: EU or Sovereignty
It’s been claimed that the EU’s future is assured because it has the political will needed. We argue the opposite. The EU has held together thus far because its leaders have done a good job deferring as much of the pain as possible with loans to the insolvent and printed money, or the promise of it when needed.
As we’ve argued often before, it’s made little progress integrating, and it’s far from clear that either debtor or creditor nations are willing to accept the sacrifices required, particularly the ceding of control over their own fates to central bodies that may be dominated by those with very different priorities. For example, recent electoral results in both nations suggest, Germans are not ready to have their money spent by Italians, nor are Italians ready to be told to cut back by Germans.
In short, the EU economy is broken and the EU’s bureaucracy is not even organized in a way that can fix it, even if it had a clear idea of what to do.
3. Market Confidence in EU Remains: Resilience or Denial?
If you look at daily or weekly charts of your favorite risk barometers, whether they’re stock indexes or major currency pairs, it’s clear that markets remain confident the EU isn’t at imminent risk. Most risk assets pulled back, but only modestly.
Cyprus and its ramifications for the EU was the big market driver last week. Here are the rest.
US, China Growth Continues
Events in the US and China (assuming you trust Chinese data) continued to confirm their respective growth stories.
Risk Rally Continues Despite Lack of Justifying Fundamentals
Despite events in Cyprus, and continued real political trouble in Italy, the risk rally continues despite
- Earnings outlook for Q1 2013 shows earnings flat or declining
- Effects of US sequester to grow
- US, Japan growth struggling
- Global recession
- Ongoing crisis threat in EU
Technical Picture: Risk Rally Barely Dented
The S&P 500 and other risk barometers barely stalled last week despite markets having a host of reasons to take profits. The rally remains not only intact, but also not even threatened, from that technical perspective.
Say “Nyet” to Currency Risk, “Da” to Currency Diversification
Some very big EUR depositors in Cyprus banks learned a painful lesson. Those exposed to the other GIIPS nations no doubt are taking note. Meanwhile Japan prepares to devalue the Yen, and the US is actively churning out $85 bln per month in new dollars. See here or here for details on the latest guide to safer, simpler ways to diversify your assets and income stream by currency exposure.
DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.
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