Fundamental Report – March 26, 2013: Euro Heads Lower Despite Bailout Deal for Cyprus

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The US Dollar is gaining on the Euro into the start of the week, as investors have largely ignored the latest bailout deal in Cyprus, based on concerns over capital flight and the possibility that bank liquidity issues could still create financial problems for the surrounding areas. The latest news is that the Troika (made up of the IMF/EU/ECB) agreed to terms needed for freeing loan funds to to distributed to Cyprus, and the initial reaction was a spike higher in the Euro. This optimism was short-lived, however, as all of the resulting rallies were quickly sold as the broader market continues to grapple with the possibility of bank runs and disruptions in the credit system. Prices in the Euro are best indicated in the EUR/USD pair, which is now trading back at its lows for the year.

Most of the attention is being placed on Laiki Bank (which is the second biggest lending company in Cyprus). Plans call for the bank to be split-up, with unsecured deposits over 100,000 Euros transferred to a holding bank. Losses in unsecured deposits could reach as high as 40% for individuals in some cases. Deposits in secured accounts will be transferred to the Bank of Cyprus, with the total process expected to raise more than 4 billion Euros. Additional funding will be generated by asset privatization and tax increases, with the ultimate goal of creating 10 billion Euros in aid in the next few weeks.

Reactions to the Bailout

So far, traders have shown a general lack of enthusiasm for the bailout deal. The main issue is whether or not the planning in Cyprus matches the precedent that has been set in the larger Eurozone countries, as any deviations here could cause conflicts, disagreement, and market uncertainty. Additionally, bank depositors in countries like Spain will likely lose confidence in light of possibly losing 30-40% of their bank accounts if problems escalate. Overall, this does not create an incentive for investors to leave money in Eurozone banks, and the results we are seeing so far include a weaker Euro, even in the face of “positive” headlines that show bailout agreements have been reached. With all of these factors seen in combination, there is little argument for a stronger Euro (at least against the US Dollar) in the coming weeks.

 

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