Cyprus Contagion Spreads As European "Omnishambles" Return; Euro Under 1.28 For First Time Since November

While everyone likes to hate on Cyprus, it is Italy that is the focal point of today's European "omnishambles" that has seen the EURUSD tumble to a five month low as of this writing. First it was economic data that scared investors, with Industrial Sales and Orders tumbling far below expected, posting numbers of -1.3% and -1.4%, respectively, on expectations of an increase. Retail sales were just as ugly, declining by -0.5% in January, on expectations of an unchanged print, with the December 0.2% number revised also into negative territory.

Then Bersani, who has been tasked to form a government until tomorrow, said that the possibility of a broad coalition government does not exist, adding that no lasting government is possible without him as a premier, and requesting that Grillo's Five Star party not block his path to government, for which we wish him the best of luck as moments later Five Star ruled out all external support for a broad government and would vote no confidence for Bersani.

Then we got news that the Italian financial police has searched the Nomura in Milan in connection with the Monte Pasci case, which means even more skeletons in the closet are about to be uncovered. Finally, Italy just held a 3.5% 5 and 4.5% 10 year bond auction in which the country raised less than the maximum targeted €7 billion, and in which the Bid to Cover on the 5 Year dumping to the lowest since 2002, with bidding quite soft and the yield rising to 3.65% versus 3.59% previously. This has resulted in a blow out in Italian yields by 16 bps to 4.73% compared to 4.705% earlier.

Not helping matters was Euroarea March Economic Confidence which dropped from 91.1 to 90, missing expectations of a modest dip to 90.5, with declines seen in the Services, Retail, Construction and Business categories, and only Consumer rising modestly. The recent Cyprus risk flare out should put an end to that.

As for Slovenian bond yields, especially the 4.375% of 2021, one word: whoooooosh.

End result, as noted yesterday, has been an acceleration in the rush out of the EUR, with the EURUSD sliding to under 1.28 for the first time since November 21, a blow out in Greek bonds with yields pushing up 55 bps to 12.68% and a push for real safety (sorry, not the DJIA) in the form of German 2 Year bonds, which have dipped to -0.018%, the lowest since December, on rising fears that despite endless lies out of its bureaucrats, Europe may not be fixed after all.

Keep a close eye on Cyprus where as of right now, banks are still set to reopen tomorrow, and where moments ago the Central Bank demanded the resignations of both Laiki and Bank of Cyprus bank boards. Hardly a stamp of trust and approval 24 hours before the bank run begins.

In terms of broad activity, here is SocGen's overnight take:

The broad equity market complex tentatively moved on yesterday from the Cyprus bailout with the USD following risk assets higher despite two disappointing US economic reports, one on consumer confidence and the other on new home sales. There was some reprieve in the confidence data in that labour market conditions, and thus employment growth, are holding up. This should reinforce the positive momentum as we head into Q2, but it remains too soon for the Fed to take its foot off the accelerator. To this end, markets will be listening attentively to what Fed members Rosengren, Pianalto and Kocherlakota have to say.

US pending home sales come out today, while the focus in Europe will be on the Italian bond auctions (2018/2023) and the monthly confidence reports from the EC. The latter are set to highlight a possible worsening in economic conditions as we head towards the end of Q1, with the Cyprus bailout and ramifications for the European bank resolution framework i.e. bail-ins, possibly causing a further dent in household confidence in early Q2. A raft of Italian data is due, but the focus will be on Bersani's report to president Napolitano on his latest government talks. As discussed yesterday in ‘SEK: a double whammy', SEK bulls could be strengthening their grip on EUR/SEK which may cause a return to the February lows below 8.30 in the event of strong confidence data.

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Finally, here is the traditional recap from DB's Jim Reid:

A day after sending markets into a spin Eurogroup President Dijsselbloem reiterated that “risks (of bank failures) should fall on those who take the risks, and not the taxpayer”. Interestingly, Mr Dijsselbloem said that he didn’t regret his comments earlier in the week and that Cyprus “does fit into the new approach towards bank rescues that is gradually evolving” (WSJ). Officials at the ECB seem to hold a slightly different view though with Beniot Coeure from the ECB’s executive board commenting that he thought Mr Dijsselbloem was “wrong to say what he said”. Those comments were echoed by Ewald Nowotny who stated that Cyprus is special case and is "no model for other instances".

In Italy, media reports suggest that the centre-left’s Bersani will meet with party leaders from the 5-Star Movement today, as part of his negotiations with major political parties to form a government. Bersani will report the results of his talks to President Napolitano later today or tomorrow. As far as current progress is concerned though, hopes of a working coalition with the centre-right’s PDL look bleak. PDL party secretary, Angelino Alfano told reporters after a meeting with Bersani yesterday that "our positions are still very distant from each other, and if they remain distant in the next 48 hours we will affirm that the only way is to go back to vote". So it looks like we will be hearing more on this in the next day or two.

Turning to Asia, the situation on the Korean peninsula remains a focus with the WSJ reporting that North Korea has ordered the country’s rocket and artillery units to be on highest alert to strike bases in the US mainland, Guam, Hawaii, and other targets in the Pacific and South Korea. The article says that the move comes after the US and South Korea signed a military contingency plan to respond to potential attacks from North Korea. South Korea earlier raised its alert level near the demilitarised border zone but that alert has been lifted as we go to print. For the time being, the news has had a muted impact on the KOSPI (+0.4%) and the Korean Won (-0.5%) but a number of Korean defense stocks are up 5 to 10% overnight.

Elsewhere in Asia equities are trading higher across the region on the back of the S&P500’s solid gain yesterday. There has been little news flow in the region outside of Korea. After a bout of risk aversion over the last week, USDJPY has resumed its climb and is trading 0.3% higher this morning at 94.75. Regional credit markets are 1-2bp firmer this morning while 10yr UST yields remain steady at 1.91%.

In terms of the day ahead, the Eurozone’s economic sentiment survey for March, Italian industrial orders and retail sales are the main data releases in the euro area. Italy will also auction 5yr and 10yr bonds. In the UK, the Bank of England’s Financial Policy Committee is due to publish a report on the capital levels of UK banks. Across the pond, US pending home sales for February will be the main focus. Several members from the Fed are scheduled to speak today including the Boston Fed’s Rosengren, the Cleveland Fed’s Pianalto and the Minneapolis Fed’s Kocherlakota.