Seven Cyprus Ramifications And Other Lessons For This Week Part 1

Lessons last week’s market action taught us for this week- Part 1

Here’s what we learned from the prior week’s market activity. The idea is to provide a quick summary of the top market drivers each day on all three continents, and then derive whatever useful conclusions we can for the coming week and beyond. I do this because I need it and no one else does it.

First, here’s a quick wrap up of what happened and what caused it each day in all three regions.

Monday: Early Rally On Cyprus Deal Reversed By Dijesselbloem Remarks

Asian indexes closed mixed mostly higher, Japan (1.69) and Honk Kong (0.61) strongly higher on news of a deal between Cyprus and the EU. The key point was that the deal left insured deposits untouched, and thus dodged the dangerous precedent of violating the protection of EU deposit insurance. That risked undermining confidence in the safety of EU bank deposits, particularly in GIIPS nations, and encouraging bank runs that could start a new and potentially fatal chapter in the EU crisis.

While much detail was missing, it was clear that deposits of over the 100,000 euro limit of EU deposit insurance at the two largest banks would bear the full burden, and that there would be at least some temporary capital controls. Those controls had some correctly realizing that Cyprus while these remained in effect Cyprus was in reality out of the Euro-zone because a Euro in a Cyprus bank wasn’t as liquid, and thus worth as much, as a Euro elsewhere in the EZ.

EU solidly lower about 0.6% typically after a strong early rally that fell apart as euphoria about the new EU-Cyprus bank bailout deal collapsed. The cause of that breakdown was Euro group’s Jeroen Dijsselbloem’s excessively honest comments that the bailout deal would be a template for Euro zone bank rescues. These words re-ignited fears about the safety and liquidity of bank deposits, and thus of bank runs, in the EU, especially in the EU’s soft spot – GIIPS nations’ banks. It was bad enough if he was referring to “bail-ins” by uninsured depositors, but even worse if he was referring to capital controls and border checks.

He and the rest of EU officialdom quickly began backtracking on that statement. European indexes would spend the rest of the week trying (unsuccessfully) to recover from concerns about EU bank deposit safety. See the Conclusions and Lessons section below for more on that.

As the week progressed, it became clear that capital controls were indeed part of the deal. How long they’ll be in place is unknown, probably for as long as Cyprus sees a threat of bank runs. That could be a long time, because it’s hard to see why any foreign depositor would want to keep funds in Cyprus anymore.

US indexes closed moderately lower, about 0.35%, and in fact recovered from deeper losses after Dijsselbloem attempted to revise his earlier statement on how the Cyprus bailout was a template for future EU bank failure resolutions. Also helping US stocks was NY Fed’s Dudley saying the US must continue with stimulus because of the weak jobs market.

Tuesday: Markets Rise By Focusing On Good US Data, Ignoring The Bad, Stimulus Hopes Support Japan

Asian indexes closed mixed mostly lower on continued worry that the Cyprus deal could yet cause contagion because of its precedent setting losses to uninsured depositors and capital controls. Losses were capped in Japan and those related to it by (what else?) hope for more stimulus being announced at next week’s BOJ meeting. New Governor Haruhiko Kuroda reiterated the BOJ’s determination to expand its balance sheet more aggressively in order to stop deflation, and push down bond yields of all maturities via purchasing longer dated (as well as the more customary short term) Japanese government bonds.

European indexes were mostly solidly higher, over 0.5%, as investors focused on better than expected US durable goods and house price data, and ignored much worse than expected consumer confidence and manufacturing data, and also shrugged off the worries about Cyprus-inspired GIIPS banks runs and Italy’s continued inability to form a new ruling coalition.

US indexes were also solidly higher as the DJIA hit a new high and the S&P 500 closed a mere 2 points below its all time high as traders followed Europe’s cue of focusing on the good US data and ignoring both the bad data as well as the mess in Cyprus and Italy.

Wednesday: Asia Up On Follow Through From US, Europe And US Down On Italy, Cyprus, UK Concerns

Asian markets closed higher on good US data for home prices and durable goods.

European indexes were down hard, around 1%, on concerns about unresolved long term political instability in Italy, contagion risks from the evolving Cyprus crisis, and downbeat Bank of England comments on the massive risks to UK banks and thus the need to raise their capital requirements.

The plunge also hit the EURUSD, sending it to fresh monthly lows, breaking near term support and ultimately heading lower to test deeper support

US markets closed mixed with overall only minor pullbacks as an down opening was used as buying opportunity, for all the same reasons that have kept US markets rising towards historic highs despite bad data from most of the developed world, a US economy still nowhere near 2007 levels, and declining earnings (stimulus and…anything else besides hopes for more stimulus?). Optimistic comments from two dovish Fed Presidents also helped. See our Conclusions and Lessons section below for an important lesson from Fed President Evans.

Thursday: Asia Mixed On Follow Through From US, Europe, US Both Up On Smooth Cyprus Bank Opening, Focus On Positives In German Data

Asian indexes were mixed, with Japanese indexes down hard on Italy’s rising borrowing costs and how Cyprus bank re-openings will go. Chinese indexes were down harder on worries over new restrictions on the property sales and China’s infamous wealth management products, which are part of an unregulated and opaque shadow banking industry.

European indexes ended higher due to a smooth bank re-opening in Cyprus, despite mixed data from Germany showing better than expected retail sales but a worse than expected unemployment change.

US indexes closed solidly higher as a combination of momentum and follow through from Europe helped push indexes higher and the S&P 500 to a new all time high of 1568. US economic reports were bad, with both first time jobless claims and Chicago PMI worse than expected.

Who needs fundamentals like economic and earnings growth when you’ve got plenty of stimulus and most other markets look worse?

For the US, Europe, and much of Asia, Thursday was the end of a shortened trading week due to Good Friday.

Friday: Most Markets Closed For Good Friday

With so many markets closed the day had little significance.

Of the Asian indexes that were still open, the Nikkei, Kospi, and Shanghai indexes were all up about 0.5% on combination of Asian fiscal year end window dressing purchasing, upbeat mood after the new S&P 500 all time high of the prior day, capped by some profit taking on caution ahead of a busy week ahead that includes 3 major central bank rate statements and US monthly jobs reports.

European and US stock markets were closed for good Friday. Forex markets were open, but trade was quiet.

See part 2 for conclusions and lessons derived from the above.