– EUR down but not out as headline risk persists
After an initial rally that stopped just short of 1.3050, EURUSD fell sharply to trade around 1.2850. The market’s uneasiness about the implications of the Cypriot deal were reinforced by comments from the Dutch Finance minister and Eurogroup Chairman Jeroen Dijsselbloem who was initially quoted saying that the Cyprus bank restructuring should serve as a template for the euro zone banks. While these comments were partly retracted, markets have interpreted the message as an indication that private sector bail-ins will need to play a greater role in any future bailouts. Peripheral bond yields were higher yesterday to 4.61% for Italy’s 10y bonds (+15bps) and 4.96% for Spain (+20 bps). Clearly, European leaders will need to address contagion in the coming days especially as banks are due to open in Cyprus today. The Cypriot central bank confirmed that it intends to implement capital control measures. Italian politics are also of concern for the EUR as Peirluigi Bersani’s chances of forming a government in the next few days appear slim at the moment. Rumours of a possible Italian credit rating downgrade have been also weighed on the EUR. Ultimately we do not believe that the fallout from Cyprus and Italy is likely to spread to a renewed debt crisis as long as the ECB remains credibly committed to backstopping the euro zone financial markets. We see an initial level of support for EURUSD around 1.2800 (see chart). Eurozone bond yield spreads indicate that the EUR should be trading higher and BNP Paribas STEER – our short-term fair-value model – indicates that the EUR remains oversold with a fair-value of 1.3270.
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BNP Paribas