STOCK MARKET WATCH -- Wednesday, 20 March 2013

[Ghost Dog]

18. The Big Picture

Cyprus is dominating the markets after Parliament rejected the bank levy plan. With risk aversion rising, EUR/USD has fallen, stocks have fallen and gold is up modestly. But Asian stocks are mixed this morning and EUR/USD hasn’t moved that much since the rejection was announced, suggesting that the market may be rethinking whether the problems of this small island are really systemic.

These negotiations are following the usual pattern for the EU. Reaching an agreement on an adjustment program has always been difficult and taken several attempts. We still believe that some settlement is likely, indeed inevitable, but until it is passed the markets are likely to remain nervous and risk-off.

The Cyprus Parliament is acting with some pressure, as the provision of emergency liquidity assistance (ELA) funds from the ECB to Cyprus would normally expire today. Removing that aid would impair Cyprus’ ability to make transactions with the rest of the world. After the “no” vote, the ECB released a statement saying that it “reaffirms its commitment to provide liquidity as needed within the existing rules.” The statement is ambiguous as the existing rules require banks receiving the funds to remain intrinsically solvent.

According to the local press, there are several “Plan Bs” under discussion in Cyprus. These include:

- Negotiating a better package from the Eurogroup.

- Splitting the banks into “good” and “bad” banks, as is often done in countries with troubled banking systems. One idea is to have the “good” bank guarantee deposits up to the EUR 100k deposit insurance limit and the “bad” bank take over the larger uninsured deposits. That might result in the large depositors taking an even larger hit than the 9.9% originally planned, however.

- Offering large depositors a voluntary haircut in return for bonds indexed to the country’s as-yet undeveloped offshore natural gas reserves in the Mediterranean Sea. The depositors might find that a more attractive alternative than the above idea.

- Tapping the Social Security funds, which have EUR 5.2bn in assets.

- Negotiating further assistance from Russia. Some ideas here reportedly involve selling troubled Popular Bank of Cyprus (Laiki) to Russia. Russia might seek a naval port in Cyprus for the Russian fleet and access to the natural gas in return.

- Russia’s Gazprom may present a private bailout plan that would involve buying exploration rights to the offshore gas, according to the New York Times. This would not only add to the company’s reserves but also prevent a competitor from providing Europe with an alternative to Russian gas.

The rescue ideas involving Russia add an unusual geopolitical dimension to this rescue that other troubled Eurozone borrowers don’t have. It may well be that security concerns trump EU politics and give the Eurozone an added incentive to come to a mutually agreeable solution.

Today there is plenty to move the markets besides Cyprus. The UK budget will be announced and all eyes are on what changes the Chancellor may make to the Bank of England’s mandate. Also the FOMC meeting ends and Fed Chairman Bernanke will hold a press conference. The statement is likely to indicate some improvement in the recent economic data, but a lower forecast for US growth this year due to the government sequester. Fed officials have made it clear that the recent improvement in the labor market isn’t enough to allow them to back off on the extraordinary easing measures, so we do not expect any change in asset purchases or guidance on policy...

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