Once again we are reminded of the huge challenges facing Europe trying to transform an imperfect currency union into a sustainable project. Bailing-out Cyprus which first involved all depositors but then altered to only involve deposits above EUR 100k will make euro-investors anxious for contagion. The unfortunate (and honest?) comment from the Euro group leader Dijsselbloem yesterday (“Cyprus bank restructuring plan should be seen as template for rest of euro-zone”), that later was denied from the official sources, states some obvious conclusions: Only last year, Euro group countries agreed to move towards a banking union to deal with the inherent problem of lacking sufficient common framework for supervision and to protect depositors. That initiative has taken some damage now. Furthermore the EMU once again demonstrates the lack of political will and ability to push the fiscal and political integration forward, which is inevitable to achieve a long-term euro sustainability (debt restructuring/write-down would facilitate this process in EMU). The lack of such initiatives will continuously attach a risk premia to the euro, already being close to our long-term fair value estimate. In the latest Currency Strategy (Jan 23rd) we had a short-term upside bias for the euro based on temporary rising portfolio flows (reallocation into euro assets) before rising political risks once again would generate a material weakening. With the benefit of hindsight, the Italian elections and the Cyprus bail-out have earlier than anticipated brought back political risks to markets attention. We downgrade additionally our euro forecasts but keep the 2014 EUR/USD target at 1.20 for now.
Click here to read the full report: FX Ringside
SEB