Spring is in the air and similar to the last three spring seasons, issues related to the Euro zone has taken center stage injecting a modicum of fear back into the capital markets. Although US investors were treated to an early fiasco in the form of the Italian elections, the banking disaster in Cyprus is now the main event driving market trepidation.
The Cyprus crisis continues to drive implied volatility and negative market sentiment. It has become clear that the creditors are demanding 5.8 billion of Euros from Cyprus, but Cyprus officials continue to pursue particularly onerous ways of raises those funds. The initial plan by the ECB concocted during the prior weekend was that all depositors would be tax was knocked down by the Cyprus government. Meanwhile Banc de Swiss tweeted “Popular Bank imposes 260 euro per day limit on ATM withdrawals”.
The newly elected President had favored the tax on small depositors, which has been surprising to market participants. He has reportedly discussed the idea of capturing the state pension assets and in exchange providing government bonds backed by future revenue tied to the gas discoveries and then raising the remainder with a tax on large deposits.
The ECB, which had previously threatened to deny Cyprus banks access to any more emergency lend funds, appears now to have given Cyprus the weekend to reach an agreement.
Banks in Cyprus are still not open and the natives are definitely becoming restless. The crisis started with the deterioration of a large Cyprus bank which prompted the ECB to threaten to cut off access to the emergency lending assistance. A stoppage of lending would have set off a set of events that could lead to the collapse of the entire banking system in Cyprus. The IMF, which had in recent weeks been signaling that depositors were vulnerable, are in favor of keeping small depositors whole.
The Cyprus Problem
Cyprus has an interesting dynamic within its banking system which is driving market trepidation. Cyprus is a small country. It makes up approximately .25% of the total EU GDP and initially was considered too small by many to be able to generate systemic issues and not qualify for EU assistance.
The most important issue surround the Cypriot banks, are large sums of legally questionable funds which qualifies the nation as a true tax haven especially by Russian nationals. Estimates suggest more than half the deposits in Cyprus belong to non-residents. Once of the main criticism facing the ECB and the initial way they handled this crisis was not immediately discussing how they would move forward with the Russian Government. Russia now seems involved in coming up with a solution that would be beneficial to all party, including those that have significant deposits in Cyprus.
The ECB initially requested an immediate tax on depositors in Cyprus. Large deposits, which are defined as in excess of 100k euros, would lose 9.9%. The government will take 6.75% from small depositors. This platform of recovery was expected to raise 5.8 billion euros.
Despite all of the issues related to Cyprus, peripheral European bond markets are firm. The bond market in Europe is the catalyst for trepidation and should be monitored by those who are concerned that the issues related to Cyprus could spill over into the US capital markets. The issues related to the Cyprus turmoil and the negative political developments in Italy failed to hinder the performance of a recent Spanish debt auction. Spain sold 4.51 billion of bonds on Thursday, maturing in 2015, 2018 and 2023. The auctions were considered a success with prices initially rising driven the yield on these bonds lower.
The initial EU purchasing manager’s prints for Germany and France were disappointing, which is more surprising for German on the heels of a better Zew survey and France. German manufacturing purchasing managers index declined back below 50 (the boom bust level) to 48.9 and the services reading fell back to 51.6 from 54.1. While first quarter Gross Domestic Product may still be positive in German, it is clear that with headwinds from other EU nations is spilling over into Germany. France saw a small increase in its manufacturing purchasing managers index, but at 43.9 (from 43.6), is still extremely weak. The PMI services report in France saw a decline from 41.9 from 42.7. Earlier in the week the German ZEW survey showed improvement reflecting a current situation of 13.6 from 5.2.
UK weakness has not assisted economic issues across the pond. The UK budget projected 61 billion pound shows more borrowing through 2017-2018 than anticipated. That means the peak in debt/GDP will not be seen until 2015-2016 and will be over 100%. This may spur more speculation of a credit downgrade by Fitch and S&P. The UK is in need of additional stimulus to spur on their GDP which is slightly below zero and could push the nation back into recession. Further austerity in the UK would only be a hamper to further economic growth. As a large trading partner of Germany, which is export driven, the lack of economic firepower in the UK is a headwind for the EU.
Equity prices in the US have been slightly altered by the Cyprus events, but the main weakness has come in the commodity space. Weak EU data continues to be a drag on the Euro, which has helped buoy the dollar. The robust dollar has generated liquidation in the commodity space, especially in petroleum. Oil prices globally have slipped to the lower end of the current ranges, generating negative price action on energy released equities during the past week.
Additionally, the issues related to Cyprus have generated increasing implied volatility expressed by the VIX volatility index, which is known as the fear gauge. The VIX, which is a measure of S&P 500 index implied volatility jumped nearly 17% earlier in the week and still remain elevated relative to the recent lows. The MACD (moving average convergence divergence index) has generated a buy signal on the VIX where the index moved from negative to positive which could lead to further upside momentum on implied volatility.
This post comes from Marcus Holland of www.financialtrading.com