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3 “Make-or-Break” Hours for Cyprus and the Euro

3 “Make-or-Break” Hours for Cyprus and the Euro

Boris Schlossberg, Kathy Lien,

Cyprus is expected to vote on a proposed rescue package in the next few hours, and the outcome of that vote will no doubt have massive implications not just for the country, but also the Eurozone and the shared currency.

In the words of the Cyprus government, "The next few hours will determine the fate" of the country and the currency it shares with 16 other nations. The EURUSD is trading extremely well this morning on hopes that Parliament will approve their latest plan to avoid bankruptcy and immediate withdrawal of liquidity support from the European Central Bank (ECB). A vote is expected later this evening in Cyprus (afternoon in North America), but the deal is still evolving as we speak.

With no help from the Russians, the latest plan involves restructuring Laiki Bank, the country's second-largest lender, nationalizing pension funds, conducting an emergency bond sale, and taxing deposits over EUR 100,000 euros (the word is a “one-time 15% tax” on deposits over this amount). Originally, angry demonstrations in Cyprus led the President to take the deposit levy off the legislation, but the Germans criticized the government for their dangerous plans to raid pension funds of state-owned businesses.

The first test is whether this deal passes Parliament. If it does, it still needs to have the full endorsement of the Troika. According to Bloomberg, Eurozone Finance Ministers want Cyprus to restructure its two largest banks, freeze uninsured deposits over EUR 100,000, and tax them at a rate that could be as high as 40%.

This is a continually evolving situation, and for this reason, we are surprised by the resilience of the EURUSD because the stakes are high and the odds are stacked against Cyprus.

Nonetheless, Europe's currency, along with its stocks and bonds, are taking the developments in stride today, and we can't ignore that. Investors clearly feel that with the ECB holding their liquidity line hostage, Cyprus has no choice but to reach a deal by Tuesday. If they do, the EURUSD will soar in relief, and if they don't, it could drop to fresh year-to-date lows.

The next few hours are critical because if Parliament rejects the legislation once again, the government will have to go back to square one, and time is running out. Along these lines, we expect rallies in the EURUSD and other major currencies to remain limited until there is a resolution.

Euro Shrugs Off Ominous German Data…For Now

Elsewhere in the Eurozone, the latest economic news shows further deterioration. The German IFO sentiment survey dropped to 106.7 from 107.8 forecast. The survey posted a decline for just the first time in five months, although the news had little impact on the EURUSD, which remained above the 1.2900 level in morning European dealing while all eyes remained keenly fixated on Cyprus.

Fresh concerns about the credit markets clearly weighed on business sentiment and demand began to taper off. This is the first drop in the IFO reading since September and may be an ominous sign that the Eurozone economy is beginning to worsen instead of improve as the quarter progresses.

See related: EUR/USD Facing Dangerous Double Whammy

This possibility is being ignored by the markets right now while Cyprus dominates all flow, but when traders’ attention turns back to fundamentals, the prospects for negative growth in the Eurozone not just for the first quarter, but perhaps Q2 as well, could start to sink in. That could put fresh downward pressure on the unit once the Cyprus fiasco is off the front page.

With no US economic data on the calendar this morning, the focus is exclusively on Europe. Fed Governor Sarah Bloom Raskin spoke this morning, and her comment that the central bank plans to keep interest rates low for a considerable period of time is consistent with her generally dovish bias.

By Boris Schlossberg and Kathy Lien of BK Asset Management

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