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The Cyprus Outcome Many Aren’t Expecting

The Cyprus Outcome Many Aren’t Expecting

Kathy Lien, Boris Schlossberg,

The bailout proceedings in tiny Cyprus are still containing price action in virtually all major currencies, and while many are expecting resolution today, a “no” vote—or no vote at all—are both potential outcomes as well.

The EURUSD spent most of the overnight trade in a very tight range as markets kept a close eye on the developments in Cyprus, although better-than-expected German ZEW sentiment numbers helped lift the pair to 1.2950 by mid-morning European dealing. The price action in the EURUSD was highly contained while lawmakers in Cyprus tried to refine the EU rescue deal to make it more palatable to the general public.

The latest iteration called for a tax levy of 12.5% on deposits above EUR 500K, 9.9% for those at EUR 100-500K, 6.75% for those with deposits at EUR 20-100K, and more importantly, no levy on those with deposits of EUR 20K or less. The change in the proposal was driven by the global outcry over the fact that small depositors who should have their savings guaranteed were forced to share the cost burden with large depositors.

Although in reality the 6.5% tax was a far better deal for most Cypriot depositors than the prospect of a full-blown banking collapse, the symbolism of confiscating savings created an uproar among many market participants and raised fears of possible bank runs across peripheral Europe because savers in Spain, Italy, and Portugal may feel that their capital was not secure.

Still, Cyprus will only remain on the radar until some sort of deal is passed. Regardless of the fairness of the actions, the currency market’s only concern is that the current situation does not devolve into a contagion, spreading counter-party risk to banking centers elsewhere in the Mediterranean.

What If They Vote “No”…or Don’t Vote at All?

The Cypriot Parliament is set to vote today at 6 pm local time (4 pm GMT, noon ET), but with the country's Finance Minister headed for Russia and the President in continuing talks with German Chancellor Angela Merkel, we would not be surprised if the vote is delayed or postponed.

If, on the other hand, the vote passes and crisis is averted, the EURUSD could see a relief rally towards the 1.3000-1.3050 level, especially given the modestly positive ZEW data that showed current conditions improving to 13.6 from 6 the month prior.

Our opinions about the levy aside, we don't expect Parliament to approve the levy right away in the first round of voting because it would be political suicide. While voting “no” to the levy could mean economic suicide, rejecting it would give the Cypriot government justification to start discussions with the rest of the Eurozone on alternative ways to raise revenue. Therefore, a “no” vote on the levy may not drive the EURUSD immediately lower.

The lack of further losses in the EURUSD or substantial losses in European stocks earlier today suggests that investors are handling the crisis well, but we continue to be wary of how long this stability can last. Currently, 1.2880 is the key EURUSD support level to watch.

See related: 3 Safe Harbors from the Cyprus Debt Fiasco

New Concerns About the US Economy Emerge

In North America, the economic calendar is relatively barren, though this morning’s housing data may have a mild impact on USDJPY. The pair traded to a high of 95.75 in Asian trade, but the rally has fizzled after the delay in Cyprus raised risk-aversion concerns.

US housing starts and building permits were released this morning, and the data was mixed. Housing starts rose 0.8% in the month of February, which was an anemic rise after the 7.3% decline the previous month. Building permits rose 4.6%, up from a downwardly revised 0.6% decline in January.

Taking the previous month's revisions into consideration, the data wasn't nearly as bad because starts and permits both increased, but it wasn't unambiguously impressive either, which validates our belief that the US recovery is losing momentum in the month of March.

Today's housing data follows last week's plunge in consumer confidence and yesterday's decline in builder confidence. This coupled with the uncertainty in Cyprus provides reason for caution for the Federal Reserve, which meets tomorrow.

By Kathy Lien and Boris Schlossberg of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.