It has been a rollercoaster ride for the markets this afternoon as Cyprus’s government voted against the bank levy proposal by 36 votes, 19 abstained (including the current government) and no one voted in favour of it. This throws the EUR 17 billion bailout plan for Cyprus into jeopardy. This is a major concern – Cyprus needs to get its hands on cash urgently, its cash reserves are running dry and it can’t afford to fund its troubled banking sector as its banks’ collateral is too low quality to even meet the basic standards required to access cheap, unlimited funds at the ECB.
So what now?
All is not lost, there are a few last ditch attempts that could pull the island-nation back from the brink of bankruptcy:
1, The EU could re-negotiate a bailout with less onerous terms, which would then stand a better chance of being passed by the Cypriot government. The bank levy would have to be dropped, however it was only ever going to raise EUR 5 billion, small potatoes in Eurozone bailout terms…
2, The Cypriot finance minister has travelled to Russia (amid rumours of his resignation, since denied) accompanied by the country’s energy minister. This could be to strike a deal with Moscow to receive cash in return for Russian access to Cypriot gas reserves. Apparently, Russian gas giant Rosneft has even declared its interest in funding Cyprus in return for licences to its gas fields.
While Russian money could help Cyprus to avoid bankruptcy, it could be the nail in the coffin for Nicosia’s relationship with the rest of the EU. The next few days are unchartered territory for the currency bloc – a potential bailout funded by a foreign country, especially Russia, throws the whole currency bloc into jeopardy. What next – Brazil bails out Spain, New York chips in to save Italy?
What to look out for the in the next couple of days:
1, Comments from EU high command. Will the currency bloc attempt to re-negotiate a new bailout for Cyprus? Will Germany back down from its demands for a bail in?
2, The outcome of discussions with Russia. Moscow was angry about the EU’s bank levy plan, and revenge could be sweet for the Kremlin.
3, The government of Cyprus will apparently reconvene on Thursday for more negotiations – presumably after the President holds discussions with the EU and Russia…
4, There is a chance an EU summit could be hastily arranged to discuss Cyprus, potentially before next week’s Easter holiday.
The “black swan” event in this situation would be Cyprus choosing to take the money from Russia and leaving the EU. This would be the most volatile outcome for the markets, in our view, which may cause Italian and Spanish bond yields to spike, while the euro and euro-based assets could fall sharply.
Market impact:
• EURUSD fell sharply in the lead up to the vote, but 1.2845 held as support. At the time of writing it was back above 1.2875 – the 200-day sma. Below here, 1.2710 – the lows from November, come back into view, but watch out as the market is starting to look oversold in the short term.
• EURJPY and EURGBP also fell sharply. But EURJPY found a base at 122.00, above the 121.15 lows from Sunday’s Tokyo open.
• Although the bank levy is off the table in Cyprus, we don’t think this will trigger a relief rally in European stocks, as it drastically increases the chance of break up risk for the currency bloc. Thus, we could see further declines for European stocks tomorrow.
• Peripheral bond markets were closed by the time the vote was called. We expect some upward pressure on Italian and Spanish bond yields. If yields have a drastic move higher this could trigger sharp declines for the euro and European stocks.
Hard hats at the ready…
