A short back and sides for Cyprus

IG - Afternoon Thoughts 'A short back and sides for Cyprus'

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EU finance ministers have approved an agreement struck in Brussels between Cyprus and the Troika that will see a major haircut being imposed on Cypriot depositors.

The deal will see the Popular Bank of Cyprus also known as Laiki Bank liquidated (shut down), with deposits of less than €100,000 being left untouched and transferred to the Bank of Cyprus. Deposits above €100,000 in the Popular Bank on the other hand will take a haircut (the write-downs are expected to be 40%), and the funds will be used to resolve the bank’s debt. With the Popular Bank owing the ECB €9 billion, this 40% could go higher. With the deal described as a banking restructure with haircuts imposed, it doesn’t have to be voted on by the Cypriot parliament, effectively taking the decision out of the people’s hands and into Brussels’.

Depositors in the Bank of Cyprus will ‘participate’ (be forced) to enter into a debt for equity swap in the bank to recapitalise it, so it can meet its 9% capital ratio obligations. Uninsured deposits will be frozen until the bank is recapitalised and should expect further write-downs once it is known how much funding is required to support the Bank of Cyprus going forward. This is not going to please the (mainly) Russian depositors who will now need to find another tax haven to store funds if they are ever released.

Risk currencies popped on the news, having moved lower in early Asian trade, with EUR/USD adding 0.32 to be at $1.305, while EUR/JPY jumped 0.77% to ¥123.62. Equity markets also jumped at the Cypriot news, with the ASX 200 adding 30 points in the 20 minutes post the deal being announced. The Cyprus deal coincided with the beginning of Japanese trade, which opened up 1.45% lead by a plunge in the yen. USD/JPY added 0.4% to ¥94.82 as investors left the safe-haven on the news.

The tactical decision to go long in risk currencies over the weekend was a good one, and this deal may now be a ‘sell the fact’ opportunity. There is no doubt that this deal has now provided precedence over the PIIGS nations and other peripheral EU countries struggling to keep their heads above water.

This deal calls into question the safety of bank deposits, as the next time one of these countries asks the ECB for funding, the bank could come back and tap them on the shoulder with a similar deal Cyprus has now agreed too. Risk premiums will increase on this deal, as will market fragmentation this Band-Aid deal will have ramifications.

The question from this morning still remains, and that is: should I invest in a bond with a higher return due to the risk premium (i.e. Italian bonds), knowing that at any time I could receive an unspecified hair-cut? Or, invest in a lower-yielding bond (German bunds) and rest in the knowledge that I will get my money back, and that if things do turn for the worst, the flight to safety will actually increase my capital?

These questions have seen the regional market wane in the afternoon session, with the ASX 200 up only 0.7% to 5001 having rallied 1.1% initially. While the Hang Seng pulled back from its open, dropping 0.7% (up by only 0.6%), the Nikkei’s sideways direction has investors questioning the avenues taken to secure the bail-out.

European markets however are reacting positively to the news, with most majors all looking like opening the local session on the front foot. However, it is the banking sectors of peripheral markets that will be the most interesting as it is hard not to see how this deal stops the fear of a possible run-on in banks.

ENDS

www.igmarkets.com

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