What Happens in Cyprus Stays in the Eurozone

What has changed since Friday?

Markets rallied on Friday on news that:

i) a deal had been reached and

ii) smaller depositors would be spared a levy on their accounts.

Markets then crumbled on Sunday night when Eurogroup president and Dutch finance minister Jeroen Dijsselbloem told the Financial Times that bailing in depositors would be a template for future solutions to the Eurozone debt crisis. When Mr. Dijsselbloem sought to avert the damage saying the bail solution was only an exception to Cyprus, the euro sell-off was already done. And so Cyprus has gone from a “special case” to a “template” in a matter of six days.

€4.2 bn will be obtained by freezing deposits greater than €100K at the wound up Laiki bank, while the bank’s bondholders will also lose all their money. Deposits greater than €100K at the larger bank, Bank of Cyprus, will not be levied, but those above €100K could lose up to 40% as part of the banks’ recapitalization. Instead of using the Eurozone’s bailout funds to save the Bank of Cyprus, Nicosia will turn to large depositors’ funds for bank restructuring.

Please don’t Explain

As EU officials attempt to justify the unique decision to bail in Cypriote depositors (lack of sufficient resources at the sovereign level, inadequate bond borrowing by banks and limiting moral hazard), the more likely that fears of “bail in” contagion across the Eurozone become justified. Not to mention the internal dissent among Troika members with regards to saving smaller depositors. Perhaps it is best that officials do not delve into the details on the uniqueness of Cyprus, otherwise, it will no longer remain unique.

The problem does not stop here.

Currency traders may have grown desensitized to the idea of failed banks, but not to 40% haircuts to large depositors, the wiping out of bank bondholders and the threat of a massive run on banks once the capital controls in Cyprus are lifted.

Even Italian and Spanish bond yields have rallied out of fear. Yields on both 10-year bonos and BTPs rose 12 bps on Monday, eyeing the 5% resistance.

EUR/USD closed below its 200-day moving average for the first time since mid-November. Although it seemed to have closed the week above its seven-week resistance, the close below its long term trend trend is more material. We have always said that breakouts above and below major trend indicators such as 200 and 100-day moving averages in liquid instruments such as the EUR/USD (25% of the daily turnover in the spot foreign exchange market) tend to be game-changers.  Whether it is the euro’s rise above its 200-DMA in mid-November, resulting from the ECB’s OMT announcement and the successful bond swap for Greece, or the euro’s decline below its 200-DMA in September 2011 on the breakdown of confidence in Italy’s banks and political certainty, the breakout has always been crucial. With four days remaining in the end of the week, month and quarter, euro bulls must hope for a close above 1.2850-55. Failure to do so would be a break of an eight-month trendine support, not exactly a small detail.

The euro’s misfortune had been especially highlighted against the price of oil. While US WTI rose to 4-week highs in USD terms at $94.70, WTI broke above a key confluence (55 and 200-DMAs), hitting six-month highs. As the price of oil in US terms shows marked technical improvement on the weekly chart (eyeing 98), oil in euro terms could be eyeing €77.50 from its current €73.62.