The Morning After

Having soared in a kneejerk response to news of the Cyprus deal which was a replica of what had been expected to take place last Friday, and thus largely priced in, it was not surprising to see the EURUSD gradually drift lower in the overnight session, printing below 1.30 at last check (and the Cyprus euphoria was not enough to push Shanghai green(. And while S&P futures ramped alongside the carry pairs early in the overnight session, the ramp has so far been contained, as the recently re-carried USDJPY pair has also refused to take out the 95.00 level in an upward direction.

In terms of events, as UBS points out, all eyes should remain focused on Cyprus today, especially since there is no data being reported elsewhere. Financial markets closed Friday on a positive note, as an agreement on Cyprus appeared to be taking shape and a minor relief rally across most asset classes overnight vindicated hopes of a positive outcome as details of the detail were announced overnight. More clarity is still required on some aspects of the agreement (deposit and bondholders) but the fact that the national parliament does not need to vote again should stop the deal from unravelling as it did last week. Whether this is enough to restore confidence and prevent a possible cautionary deposit flight from Cyprus remains to be seen.

However, the key variable now remains Russia, whose first deputy PM Shuvalov said is waiting for final Cyprus deal before reacting; does not rule out renegotiating Cyprus loan. If anyone can tip the boat on Europe now, it is Russia.

In terms of market impact, EUR/USD only advanced by one figure Friday on hopes of a likely accord and in the end finished the week at the same level as it had started it. In the same vein, the rates market reaction was just as benign, with the 10Y EUR swap rate also unchanged at the end of the week (at 1.6950%). The momentum of receiving flows should be tempered and the 1.60%-1.80% range should hold this week unless negative contagion resumes.

UBS' conclusion: all in all, turbulence from the Euro crisis is not over. Let us not forget that Italy still does not have a government and the German national parliament will have to give its seal of approval on Cyprus as we await more bailout details.

For a brief summary of the remaining overnight events, here is Deutsche's Jim Reid:

We've often talked about how dramatic European issues tend to get resolved at one minute to midnight, well for those of us in the UK, the new deal for Cyprus literally came through at almost exactly that time last night. As with last weekend’s package, the latest agreement will see the bail-in of depositors - but with the crucial difference being that insured depositors will not be touched under the new agreement. It seems from the outline of the deal provided by the Eurogroup, Laiki will be “resolved immediately” with a “full contribution of shareholders, bond holders and uninsured depositors” via Cyprus’ newly adopted Bank Resolution Framework.

The deal, which has been approved by the 17 Eurozone finance ministers as well, will see Laiki split into a “good” bank and a “bad” bank. The good bank will be folded into the Bank of Cyprus (BoC) while the bad bank will be wound up over time. BoC will assume EUR9bn of Laiki’s ELA liabilities, and will be recapitalised through a deposit-to-equity conversion of uninsured deposits such that a capital ratio of 9% is achieved. The bail-in of large Laiki depositors will contribute about EUR4.2bn to the recapitalisation. The Eurogroup reiterated that “all insured depositors in all banks will be fully protected in accordance with the relevant EU legislation”. The Governing Council of the ECB will provide liquidity to the BoC as part of the deal. The deal will unlock EUR10bn in funds from the Troika’s “macro adjustment programme” which, apparently, will not be used to recapitalise Laiki and BoC. Cyprus will receive the first funds in May.

What’s unclear at this stage is how much of a loss will be imposed on uninsured depositors at both Laiki and BoC. Unnamed officials quoted by the FT said that uninsured deposits at Laiki will be “severely cut”. At the same time, the FT and Reuters have reported that losses on uninsured depositors at BoC could be as high as 40%.

In terms of the next steps, German FM Wolfgang Schaeuble told the media that Cyprus’ parliament will not need to approve the deal given that the necessary legislation to implement the deal has already been passed. Schaeuble added that "additional legislation would only have been necessary if a levy on uninsured deposits would have been raised but (not) for restructuring of the banks in question” (Reuters). Schaeuble said Germany's lower house of parliament would not need to vote on the bailout at this stage but a vote could be held this week if legislators wanted it. Cypriot Finance Minister said the aim was now to reopen banks as soon as possible.

According to the Eurogroup, there will be an appropriate downsizing of the financial sector, with the domestic banking sector reaching the EU average by 2018. Further to that, the Cypriot authorities have reaffirmed their commitment to step up efforts in the areas of fiscal consolidation, structural reforms and privatisation. Reforms include an increase of the withholding tax on capital income and of the corporate income tax rate. There will also be agreement between Cyprus and the Russian Federation on a financial contribution. The IMF estimates that Cyprus debt will be about 100% of GDP by 2020.

In terms of the market reaction, EURUSD gained 0.5% and S&P 500 futures jumped 6pts higher on the initial headlines that the troika and Cyprus had reached an in principle agreement. EURUSD is holding above 1.300 while S&P500 futures are 0.4% higher as we type.

Gold has seen some interesting moves, selling off on the initial headlines before rallying to trade 0.2% higher overnight. 10yr UST treasuries are trading 4bp higher.

Briefly turning to Asian markets, equities are trading broadly higher with solid gains seen on the Nikkei (+1.9%), KOSPI (+1.4%) and Hang Seng (+0.8%). Chinese equities are edging lower this morning on some profit-taking following four consecutive daily gains. Regional credit markets are 2-3bp tighter this morning.

Turning to other news, Fitch placed the UK’s AAA rating on “rating watch negative” late on Friday. Sterling dropped 0.2% against the euro on the headline but recovered most of the move into the end of trading on Friday. Fitch said the action reflects the latest economic and fiscal forecasts published by the Office for Budget Responsibility that indicate that UK government debt will peak later and at a higher level than previously expected. Fitch expects to complete its review of the UK’s rating by the end of April.

Elsewhere, the International Monetary Fund is reportedly planning to cut its U.S. growth forecast from 2% (estimated in January) to 1.7% for this year due to higher taxes and spending cuts, Italian news agency ANSA said, citing a draft of the IMF's next World Economic Outlook report (Reuters).

Turning to the day ahead, the immediate focus will be on the market reaction to the weekend’s developments in Cyprus. Today’s data docket will be relatively light with the only release of note being Italy’s consumer confidence. Ben Bernanke and the IMF’s Blanchard speak today at the London School of Economics on ‘What Should Economists and Policy makers Learn from the Financial Crisis?’. The discussion will be chaired by Mervyn King and is scheduled to start at 5:15pm London time. The NY Fed’s Bill Dudley speaks today at the Economic Club of NY. Italy will auction inflation-linked bonds.

Looking ahead to the rest of the Good Friday-shortened week, the Bank of England’s Financial Policy Committee is expected to report on UK bank capital levels on Wednesday, which may be followed by announcements from banks on specific capital actions they will take. Data-wise, in Europe the highlights are French and Euroarea consumer confidence on Tuesday and Wednesday respectively. German unemployment and Euroarea M3/credit data are due on Thursday. In the US, the highlights are consumer confidence and durable goods orders on Tuesday; pending homes sales on Wednesday; Q4 GDP revisions and Chicago PMIs on Thursday and personal income/spending on Friday. In Japan, a number of key macro updates are scheduled for Friday including industrial production, CPI, construction orders, unemployment and household spending.