Euro Gets Real over Cyprus

The balance between contagion fears and mixed economic fundamentals swung in favour of the euro on reports that the Cypriote Parliament has reached a deal with regards to its banks and collecting the €6.7 bn from Cyprus instead of the previous €5.8 bn from deposits.

The focus on the Cyprus/Troika/Russia negotiations was highlighted (excessively) by the fact that EUR/USD posted its biggest advance in two weeks, despite evidence of slowing sentiment in Germany’s IFO survey. All three components of Germany’s IFO survey slowed in March, posting their first decline since September. The IFO Business climate slipped to 106.7 from 107.4. The report follows Tuesday’s release of a disappointing ZEW survey (focusing on investors) and Thursday’s release of a contraction in Germany’s flash manufacturing PMI release.

The euro’s medium term fortunes will continue to primarily rely on the likelihood for an ECB rate cut, which we deem to be minimal in H1 at this point. Shifting towards Italy, markets are also awaiting a decision from outgoing President Napolitano to grant DP’s Bersani the power to form a government as he controls the lower chamber and has the biggest number of seats in the Senate. If this option passes, then Bersani will explore the possibility of winning sufficient Senate support to win a confidence vote.

All Quiet on the Yields Front
The Cypriote panic hardly made a dent on periphery bonds. Yield on 10-year BTPs are down 9.4% since the election impasse of February 27. Spain’s 10-year bonos are down over the past four days after failing to close above 5.0%. Bonos yields have remained below 5% since the Italian election impasse in late February.

EUR/USD breaks out of its three-month downward channel after surviving above the important support of 1.2870 (confluence of 200-day moving average and 55-week moving average). We expect prolonged gains to taper off near the 1.3120-30s, were the 100-day moving average has imposed a ceiling since Feb 25. A subsequent retest of the 1.30 is then possible, before the bulls will have to take charge above 1.32, or else the US dollar’s bullish story will prevail at the expense of EUR/USD.