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Australian Dollar Vulnerable to Cyprus-Driven Risk Aversion

By , Currency Strategist
23 March 2013 04:01 GMT
Forex_Australian_Dollar_Vulnerable_to_Cyprus-Driven_Risk_Aversion_body_Picture_5.png, Australian Dollar Vulnerable to Cyprus-Driven Risk Aversion

Fundamental Forecast for Australian Dollar: Neutral

A nearly empty domestic economic calendar will not leave the Australian Dollar rudderless in the week ahead as fading interest rate cut expectations allow the currency to rebuild its relationship with broader risk sentiment trends. The priced-in RBA policy outlook no longer calls for further easing over the coming 12 months having implied 50 basis points in easing as recently as three weeks ago, according to data from Credit Suisse. The correlation between the our in-house risk appetite gauge and a Deutsche Bank index tracking the average value of the Aussie against its top counterparts is at a monthly high (0.55 on 20-day percent change studies).

This keeps the spotlight on news-flow coming out of Cyprus. The European Central Bank (ECB) had given the troubled island nation until Monday to reach agreement on an EU bailout plan before it cuts off Cypriot banks’ access to emergency funding facilities. Cyprus needs to raise €5.8 billion to unlock another €10 billion in rescue cash from the so-called “troika” (EU/ECB/IMF). Parliament passed a flurry of proposals on Friday aimed at creating the framework of a resolution. Lawmakers agreed to create an investment fund to raise the necessary capital, approved capital controls in a bid to prevent a bank run when lenders reopen after an extended holiday, and resolved to partially wind up the troubled Cyprus Popular Bank.

Ample uncertainty remains, however. Cyprus Popular will be split, with unsecured deposits (all those over €100,000) transferred to a so-called “bad bank” and eventually wound up. Such a move may translate into losses of up to 40 percent for unsecured depositors according to reports making the rounds last week. Most importantly, the controversial issue of a bank levy – rejected in a poll last Tuesday – has been shifted back to “pending” status until another 11th-hour vote is held on Sunday. The new version of the plan envisions a one-off “tax” of 22-25 percent solely on deposits greater than €100k. If ratification is successful, the levy in addition to already approved capital controls may spook savers in other Eurozone countries with a wobbly baking sector (notably Spain), prompting a much-feared mass exodus of capital that threatens to spark a regional credit crisis. Any final deal also requires final approval by the EU before entering into effect.

While the situation remains very much in flux, those pieces of the puzzle that have emerged already warn of the onset of risk aversion amid concerns about the Cyprus endgame as well as its implications in terms of setting a precedent for the region as markets return online next week. Investors have offered policymakers ample benefit of doubt thus far, but a lack of concrete answers addressing their worries may spark liquidation across the spectrum of risk-linked assets, sending the Aussie lower. Follow-through will depend on whether visible signs of contagion emerge early in the week, particularly after Cypriot banks reopen on Tuesday.

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23 March 2013 04:01 GMT