While controversial bailout proceedings unfold in tiny but troubled Cyprus, look for safe-haven currencies to stay in favor and key economic data and central bank events in the US and Japan to have a less-forceful impact on the markets.
The sharp selloff in currencies and European equities overnight indicates that investors are shocked by the Cyprus bailout news, as well they should be considering this would be the first time in Eurozone history that depositors have ever taken a loss on savings.
The EURUSD may have rebounded from its lows on speculation about a modified and more progressive deal, but regardless of how much depositors above or below EUR 100,000 are taxed, the mere possibility that they will be taxed at all undermines the credibility of the entire banking system.
Optimists argue that this situation is unique to Cyprus and won’t spread to other troubled periphery nations, but we don't know how reassuring a watered down deal will be, as this could set a precedent for the entire region.
See related: A “Monumentally Dangerous” Cyprus Bailout Scenario
Moreover, let’s not even get into how unfair it is that senior bondholders are being saved at the expense of others and that depositors with money under the mattresses are safer than those with money in the banking system. What we do know is that the Cyprus bailout has set the tone for trading in an extremely data- and event-driven week by reawakening the fear of Eurozone debt contagion.
The bailout vote in Cypriot Parliament has been postponed until Tuesday, which means that this risk-off tone will remain prevalent for the immediate future.
4 Safe Harbors Amid the Turmoil
The currencies that have benefitted the most from the news are the safe havens, which include the US dollar (USD), Japanese yen (JPY), British pound (GBP), and Swiss franc (CHF). The franc would have probably benefitted more if not for comments from the Swiss National Bank (SNB) that indicated the Bank has not excluded the possibility of negative interest rates.
The SNB has been quick to respond to euro weakness in hopes of avoiding a flight to safety into the franc, and based on the relative strength of the GBP versus CHF, it looks to be working. In fact, the perceived safety of deposits in the UK has allowed investors to completely overlook all of the country's problems, including upcoming pressures this week, which include the risk of dovish Bank of England (BoE) minutes and a negative UK budget report.
Unless Cyprus completely scraps the bailout deal because of internal and external criticism, we can't see how a good subset of depositors won't be spooked enough to shift their funds out of the Eurozone and into other parts of Europe…like the UK.
Big Events That Could Be Lost in the Shuffle
Better-than-expected US economic data may have boosted the Federal Reserve's optimism ahead of this week's Federal Open Market Committee (FOMC) meeting, but with Cyprus reawakening systemic risks, Fed Chairman Ben Bernanke could choose to be more cautious.
A new Bank of Japan (BoJ) governor will also be installed this week, and there is a press conference scheduled for this Thursday, March 21. At the press conference, we expect new BoJ officials to reaffirm their commitment to aggressive easing, which should help revive the rally in USDJPY. Because we expect Japan's central bank to increase asset purchases in the very near future, we believe dips in USDJPY should be viewed as opportunities to enter at lower levels.
Eurozone and Chinese flash PMI numbers for the month of March are also scheduled for release this week, and with the euro tumbling, Eurozone data will be in focus and weak numbers would only compound the pain. (See the complete economic calendar.)
Quite simply, the Cyprus bailout has set the tone for trading this week, and in this context, even good news from the rest of the world may be lost in the shuffle.
By Kathy Lien of BK Asset Management