At the time of writing, the banking crisis in Cyprus faces its next test as lawmakers scramble to prevent a second week of darkness for its banking system. I suspect that no matter what resolution passes all the necessary hurdles, Cyprus's banking system will remain damaged for some time to come. Even if Cyprus manages to enact laws that prevent capital flight, it is difficult to imagine much new money going into the banks from small depositors or Russian nationals. Without the general support of the average Cypriot, the banks may eventually need to get nationalized just to survive the coming years of work needed to re-establish trust and confidence.
The reaction to the Cyprus news was swift in financial markets starting with currency markets on that Sunday. By the end of the week, the S&P 500 (SPY) remained down a small fraction of a percent, the volatility index (VIX) remained elevated from seven-year lows but well off its high of the week, the SPDR EURO STOXX 50 (FEZ) closed down 1.6%, the U.S. dollar index (UUP) gained 0.9%, and gold (GLD) managed to eke out a 1% gain. Needless to say, none of these reactions reveal panic or even much concern over the eventual resolution of the Cyprus crisis.
When I wrote a week ago about potential trades post-Cyprus, I recommended gold, buying the euro (FXE) on a dip by trading against the franc, and buying the British pound on the assumption that the euro's strength against the pound had finally ended. The Australian dollar's upside did not occur to me until it broke out against the U.S. dollar late in the week. The chart below shows that the Australian dollar continues its relief rally from a brief breakdown earlier this month. At current levels, the Australian dollar has broken out versus the U.S. dollar, trading above its 200DMA and now seemingly headed for another test of the downtrend in place since 2011.
The Australian dollar emerges even stronger against the U.S. dollar post-Cyprus
Weekly chart to show the overall downtrend still in place
I remain short AUD/USD but have duly noted the building strength that now seems that it could be the next leg in the Australian dollar's stealth rally. During the week, the Federal Reserve announced its latest update on monetary policy but the overall response seemed muted. I do not think the Aussie's gaining strength has anything to do with U.S. monetary policy and instead likely represents continued appreciation of the apparent resilience in Australia's economy. The last employment report showed a surprising surge in new jobs, albeit many were part-time.
My large trade against the euro using the British pound was my best choice for the week, but I took profits after the EUR/GBP failed to follow-through on its breakdown. Holding onto the trade took a lot of patience. Thus, I will likely not re-enter until fresh weakness appears in the form of a new breakdown. For now, I continue to assume EUR/GBP has topped out for the foreseeable future.
The British pound gained ever so slowly over the euro post-Cyprus
This hourly chart shows that the British pound barely budged in Cyprus's wake. After a lot of volatility, GBP/USD managed to close stronger on the week.
The British pound was more impacted by the BOE minutes than news in Cyprus
The British pound even managed to close marginally above the presumed support that had held for almost three years. I took this opportunity to expand a very small short position in GBP/USD that served as a partial hedge on my over-sized short on EUR/GBP. Further follow-through to the upside will likely take me out of this position.
During the week, a lot of economic numbers were released for the UK, including another statement on monetary policy from the Bank of England (BOE). Net-net, it seems the market was encouraged by the lack of "worse news."
The interest in the franc as a potential "safety play" was quite brief. All losses on EUR/CHF from Sunday were reversed by the close of trading on Monday. The currency pair has just churned in place ever since then. The 200DMA seems to be holding up as support, and my preferred entry below 1.21 seems as remote as it was a week ago.
The Swiss franc gains little on the euro as a result of the Cyprus banking crisis
I continue to think of EUR/CHF as the first vote on the health of the euro. If the price action from last week means anything, it suggests the market is nowhere close to abandoning hope over the currency.
One of the bigger enigmas of the post-Cyprus week was Siemens AG (SI), the German industrial conglomerate. I like to think of SI as the final referendum on the health of the eurozone economy (although SI is a global company). Siemens did close down fractionally on Monday following the Cyprus news but by Tuesday it was trading higher than Friday's close. By the end of the week, SI managed to trade at a fresh 19-month high before settling down to its third highest close for 2013.
Siemens manages to gain momentum post-Cyprus
Source for charts: FreeStockCharts.com
Perhaps SI benefited from two analyst upgrades: to buy from Bank of America on the 18th and to overweight from Morgan Stanley on the 20th. Regardless of the reason, a continued rally from here would represent exceptionally bullish price action… and could confirm that the market is already forgetting about Cyprus's troubles…
Be careful out there!
Additional disclosure: In forex, I am net short the Australian dollar and British pound