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Why Might the Euro Continue to Fall on Cyprus Fears?

By , Quantitative Strategist  and  Renee Mu
18 March 2013 21:14 GMT

Cyprus represents a mere 0.2% of Euro Zone GDP, but a lesson from history emphasizes that recent developments could cause a much larger Euro breakdown.

OPEN

HIGH

LOW

LAST

PRICE

CHANGE %

USDOLLAR Index

10490.22

10499.21

10469.62

10473.73

0.17752

EURUSD Curncy

1.2955

1.2976

1.2882

1.2957

-0.91006

GBPUSD Curncy

1.508

1.516

1.5061

1.5115

0.006616

USDJPY Curncy

94.03

95.2

93.57

94.95

-0.34635

AUDUSD Curncy

1.0375

1.04

1.0333

1.0393

-0.15371

The Dow Jones FXCM Dollar Index rallied on a sharp euro drop through the start of the week’s forex trade. As banks in Cyprus will stay shut tomorrow following today’s banking holiday, shaken confidence over Europe may lead to higher demand for the safe-haven US Dollar.

The Cypriot Parliament has postponed its bailout vote to Tuesday and banks will remain closed at least until Thursday. Although Cyprus only comprises about 0.2% of total Euro-zone GDP, risk of contagion to depositors in other periphery countries may raises concerns over similar treatment in the future. The ‘spark’ of a deposit levy in Cyprus may trigger a much larger fire throughout the much-larger European banking sector.

Why will Euro Outlook Remain Bearish through the foreseeable future?

Over 1800 years ago, a strong army moored its ships from stem to stern, in an apparent aim to reduce seasickness of its navy who were mostly not used to living on ships. Yet it was soundly defeated as one of the ships caught fire and it then spread to every other ship. It was the famous Battle of Red Cliffs.

In Europe, we see a repeated story: countries joined in a union and become one of the strongest economies in the world. Yet good times don’t last forever. Greece first caught fire, and then Spain and Italy. Now it is Cyprus’ turn. From the old story, we know that whether a big or small ship in the group catches fire does not matter; what matters is an inevitable spark which could fast spread among all the “ships” and burn down everything before people realized what happened and take actions.

Over the weekend, we saw a potential spark called fear which triggered by the bank levy at Cyprus. Although Cyprus comprises only 0.2% of total Euro-Zone GDP, in the terms of contagion depositors in other periphery countries will worry of similar treatment in the future. Even if the euro may survive from the crisis in Cyprus this time, how many more fires can it bear? As crises in the Euro-zone become more frequent and intensedue to euro’s fundamental flaws, traders will want to keep track of whether the costs of the Euro-Zone outweigh its benefits.

Tomorrow’s German ZEW business confidence survey may likewise weigh on European growth prospects. Following three consecutive monthly increases, the index is expected to fall slightly in March according to a survey by Bloomberg News. Yet, the actual report may fall short of expectation amid concerns over ongoing Euro Zone financial crises. A worse-than-forecast report could add further fuel to the recent wave of sentiment-led EUR selling.

In the upcoming Asian trading session, Bank of Japan Governor Shirakawa is scheduled to step down. Japan’s parliament approved Haruhiko Kuroda, who is in favor of more vigorous monetary easing, as the new governor as of last week. Investors may want to keep an eye on what policy action the BOJ will take once the successor takes over and the bank meets for the first time under new leadership. Although markets anticipate that the Bank of Japan will support increased asset purchases to meet its goal of two percent inflation, questions as to how much additional monetary easing will be adopted remain of interest. We will watch the Yen and Euro with particular interest through upcoming days of trading.

Economic Calendar

Date

Time

Currency

Event

Importance

Forecast

Previous

Tue

Mar 19

04:00

JPY

Bank of Japan Governor Shirakawa Steps Down

High

10:00

EUR

German ZEW Survey (Economic Sentiment) (Mar)

High

48.1

48.2

/

EUR

Cyprus Parliament to Vote on Deposit Levy for EU Bailout Plan

High

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Written by Renee Mu and David Rodriguez, DailyFX Research Team

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18 March 2013 21:14 GMT