Markets ignoring bad Cyprus news for fear of selling?
World markets have held up well despite the dramatic turns in the Cyprus saga due to the 'huge' amounts of liquidity
As news of a tax on savings in exchange for a bailout by the European Union, the European Central Bank and the IMF sent Cypriots running to ATMs, markets by and large remained remarkably calm during the week.
By early afternoon on Friday, in a sign that patience was beginning to wear thin after a week in which the Cypriot parliament rejected the tax on deposits and Russia turned a cold shoulder to Cyprus's request for aid, world stocks were down and the euro fell.
But stock markets and the euro turned positive again later in the afternoon on hopes that a deal will be reached in which the country's second-largest bank, Laiki, would be split into a "good" and a "bad" bank and deposits under the EU-wide 100,000 euros guarantee would be protected.
Markets managed to ignore the bad news of out Cyprus for so long because investors have "huge amounts" of liquidity in their portfolios due to the central banks' policies of buying assets, Stephen Lewis, chief economist at London-based Monument Securities, told Emerging Markets.
"So they're not looking to add to that by selling other assets as well, because that would push their cash ratios up to quite unacceptable levels with which they would be uncomfortable," Lewis said.
"Consequently, they're not looking at the bad news, the news that might give them reason to sell; instead they're looking only for the good news, the kind of news that would give them a reason to buy capital assets."
"It's easy for them to persuade themselves that it doesn't really matter, that it's small, it's an island somewhere in the Eastern Mediterranean; that's the mindset. And this mindset is just created by all this surplus liquidity."
CAN DEPOSIT LEVY BE REPEATED?
But if Cyprus defaults next week and triggers a series of other defaults across Europe, this would call investors' attention back to fundamentals, Lewis said.
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Carl Weinberg, founder and chief economist at New York-based High Frequency Economics, said the expectation in the markets was probably still that the Eurogroup "will figure out some way to fix it."
"I think that market sentiment may change if and when we see a run on bank deposits in Italy and Spain, which I think is the next step in all of this," he said.
European officials have gone to great lengths to persuade the markets that Cyprus is a special case, precisely to avoid fears of contagion to other periphery countries.
Alberto Gallo, head of European macro credit research at RBS, does not expect the deposit levy to be repeated somewhere else in the single currency area.
Gallo notes that the size of the banking sector in Cyprus, at seven times GDP, is double the eurozone as a whole, Cypriot banks are between 70% and 80% funded by deposits and that it is "politically unfeasible" to require European taxpayers to bail out the depositors.
Other analysts also believe that the Cyprus bank levy is a one-off, just as it was promised by the Eurogroup, and therefore the lack of confidence in bank deposits will not spread to other eurozone countries.
"Some people will say that, and I would disagree. I certainly wouldn't want to have my retirement money on deposit in an Italian or Spanish bank right now and I can't state that I'm alone in that. We'll just have to see what happens with the haircutting here," Weinberg, who calls the tax on deposits in Cyprus a "sequester," said.
"Deposit insurance is not mutualized in euro-land, it's worthless, particularly in the case of countries with big banking systems whose governments can't afford to bail them out. Spain, Italy fit that category but so too does Belgium, the Netherlands and Luxemburg," Weinberg said.
"The weakness is: save the banks, save the world. And right now, the best way to save the banks is to mutualize the losses and to recapitalize the system and there is no effort in progress to do that."
He said that the scenario of splitting Laiki into a bad bank and a good bank suggests that big depositors will have to take a bigger haircut and lose money.
"And I think that as that reality sinks into the markets, we'll get a stronger reaction," Weinberg added.
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