Euro continues to sell off as Cyprus aftershocks ripple through markets
02/Apr/2013 • Currency Updates•
The holiday-shortened week was dominated again by the news from tiny Cyprus. The troika managed to cobble together an agreement to impose steep losses to large depositors in Cypriot banks, but the inevitable imposition of draconian capital controls means that Cyprus has de facto left the eurozone. Unsurprisingly, the euro continued to sell off against most major currencies. Away from FX, decoupling continues to be this year’s theme in financial markets. US equities are outperforming their European counterparts, while credit, commodities and the euro fail to benefit from the rally in most other risk assets.
Market-moving news were scarce during Easter week. There were some tentatively positive news on consumption. A 0.3% rebound in January services output from a 0.4% drop the previous month confirmed our view that GDP is likely to print flat or slightly negative in the first quarter. All eyes now shift to the MPC meeting next week. We expect the Bank of England to surprise consensus and announce a further expansion of the Gilt purchase program. We think that the dreadful macroeconomic news from across the Channel will push at least two more MPC members to join with Mervyn King and ease policy further. Therefore, we would not be surprised to see sterling weakness in the short term, though longer term we expect GBP to continue to strengthen against the euro while selling off against most other major currencies.
Last week provided two “firsts” in the story of the slow-motion euro train wreck. For the first time since the outset of the Eurocrisis, depositors in troubled banks were forced to bear significant losses. The latest estimate mention haircuts of up to 60% on any amounts above 100,000 Euros. Also, draconian capital controls were imposed on any euros remaining after that. While capital controls were inevitable to prevent a mad rush for the exit in Cypriot banks, the fact is that membership in a monetary union is essentially meaningless unless capital is allowed to flow freely, and therefore we have just witnessed the first exit from the euro in Cyprus. Less dramatic but equally worrisome were economic developments PMI business sentiment indicators dropped sharply in March, to 46.5. This numbers make it almost certain that the eurozone will post another contraction in output for the first quarter of 2013. The surveys were all conducted before the Cyprus crisis occupied the headlines, so we expect to see a further drop in this key leading indicator when the April numbers are released again. All in all, the tail risk of a disorderly resolution to the European crisis has risen to non-negligible levels, and we expect the euro to continue to reprice lower against both sterling and, especially, the US dollar.
Last week again brought into focus the stark contrast between dismal Eurozone data and steady improvement in the United States. Fourth quarter growth was revised modestly higher, from 0.1% to 0.4%, on the back of a strong revision to real business fixed investment, which is now growing above 13% annualized rate. It seems that corporations are finally taking advantage of extraordinarily easy financial conditions and subdued labour costs to hire and invest. If sustained, this should provide another leg of support to the US economy, together with the rebound in the housing market. We now expect the first quarter GDP growth figure to print about 3%, and maintain expectations of roughly 2.5% growth for the full year. We are already seeing this performance reflected in the equity and FX markets, as US equities and the dollar continue to outperform their European counterparts; we think that this is the trend to watch for 2013.