The focus remains squarely on Cyprus. It seems to be overshadowing everything else. However, the price action shows a disconnect - the euro itself has been fairly resilient, though lagging behind the recovery of sterling, and the dollar-bloc. Spanish and Italian bond yields fell last week and continue to slip today. Although there are many who see Cyprus as trumping OMT, leading the disintegration of the monetary union, the global asset managers are not panicking by any stretch. There is a sense of urgency, but not of emergency.
Just as the capital markets were mostly calm in the face of last week's Cypriot developments, there has been a relatively muted reaction to news that a deal has been struck which appears to avoid the worst of the potential contagions in three important respects.
First, the sanctity of small depositors was ultimately protected, though the willingness of Cypriot officials to sacrifice them and for the European officials to have gone along with the plan initially, will be remembered. Second, the traditional seniority of claims has been restored. Equity and bond investors, which had been protected under the initial proposal at the expense of insured and uninsured depositors, will now be "bailed-in". Third, while uninsured deposits and others may see assets frozen initially, the more extensive capital controls that would have potentially led to treating the euros in Cyprus differently from euros elsewhere in the euro zone, have been averted.
Reports indicate that it may take the next several weeks for the Cyprus plan to be formally approved and the country may not get its first aid tranche until early May. The fact that the package was shaped in such a way as to make it unnecessary for approval from the Cypriot parliament, which had the courage to block the president's previous plan (that was endorsed by the Troika), raises questions of democratic legitimacy. In addition, we suspect that the restructuring of the Cyprus economy away from its role as a financial center will be more expensive and a more prolonged process than currently anticipated, and warns that additional assistance is likely to be necessary.
Lastly, Russia is unlikely to be pleased. If we understand what Russian officials have been intimating, the problem is not about defending the Russian oligarchs' financial interest. After all, the capital flight from Cyprus since the start of the year has been substantial and reports suggest there have been other ways to transfer wealth out of the country, such as equity transfers. Rather, the problem is that Russia was not consulted and included in the process. We suspect that the same regime that locks up a punk rock band for criticizing it, will find a way to express its dissatisfaction with the EU and Germany.
Technically, the US dollar looks vulnerable. The trend following and momentum segment of the market short foreign currency positioning is stretched, with the notable exception, arguably, of the Australian dollar. The Aussie bulls have moved back into ascendancy amid an increased speculation that the RBA's easing cycle may be complete (we do not think it is). The risk of a US dollar downside correction seems to dovetail with the approaching month end and quarter end portfolio and hedge adjustments.
We do not place much significance on the pre-weekend decision by Fitch to put its UK rating on negative credit watch. It is the laggard among the top three agencies. S&P has put its AAA rating on review this past December and last month, Moody's had cut its rating. Fitch says it hopes to complete its review by the end of next month. We think that what led to Fitch's review, the government's admission that it now projects slower growth and higher levels of debt, will lead to a downgrade in Q2.
Separately, the service index is reported late in the week and, given the importance of this sector, a modest increase would be seen as a sign that another quarterly contraction has been avoided. The first estimate of Q1 GDP is April 25.
European economic calendar is fairly light. The two features are consumption and money supply. Germany will get the ball rolling with its February retail sales report tomorrow. A pullback after the outsized 3.1% in January is expected. Italy reports retail sales on Wednesday, followed by France's report on consumer spending at the end of the week. Thursday, the the ECB will report money supply and lending figures. Money supply growth is expected to have slowed while lending likely continued contracting.
US data is concentrated in the second half of the week. Q4 GDP on Thursday is likely to show a further upward revision. Recall the initial 0.1% contraction was revised to a 0.1% expansion - still stagnant. Now, however, it is likely to be revised to 0.5% or a little higher. It is not so important for the capital markets, but it is a useful reminder that the first estimate of GDP is practically useless and that after that Q4 slowdown, the US economy appears to have bounced back to its recent pace of around 2%, if not a little above. This will be driven home further with the personal consumption expenditure, which will show the resilience in the face of the end of the payroll savings tax holiday.
Economic data may help spur further recovery in the Canadian dollar. At mid-week Canada will report CPI figures. Seasonal factors point to upside risks, but note that the BOC will also be unveiling new weightings for its consumer basket based on 2011 spending patterns, upgraded from 2009. The core rate is likely to have continued to fall. After peaking at 2.3% last February, it is expected to be unchanged from the 1% pace seen in January. It is below the lower end of the BOC's range and reinforces the neutral stance. On Thursday, January GDP figures will be released and the economy appears to have bounced back after contracting 0.2% in December.