EURO Strangled By Options, Cyprus And Holidays

Greek and periphery borrowing costs are attempting to creep higher as investor’s fear over Cyprus dominates a strong U.S. performance. On the other hand, the U.S. investor seems to be overlooking the Cypriot drama and focusing on domestic data in their attempt to push the S&P 500 to new heights. Cypriot officials are working on capital controls before reopening the island's commercial banks tomorrow. Never too far away are the rating agencies – lurking in the background, preparing to clip the tiny island’s credit rating wings.


Safety should remain the dominant ‘flavor du jour’ whether its been promoted by Cyprus, Korea or the eurozone as a whole. The historical reserve currencies of choice – CHF and JPY – remain relatively bid, along with bonds, bunds and gilts as the markets head towards the long Easter holiday weekend. Month-end combined with Japanese fiscal year-end will persuade most investors to play it safe as liquidity becomes more of an issue over the next 24-hours.

The focus for the Yen is the Bank of Japan’s upcoming policy meeting next week. The currency from the ‘rising sun’ remains subtly in demand, despite the new BoJ governor Kuroda disclosing his policy plans for government-bond purchases and other easing measures. Policy makers will supposedly look at longer maturities and the amount of government bonds the central bank can buy. Abenomics has yet to significantly and consistently weaken the Yen. All along, this market has been positioning itself for bold moves by the central bank. Next week we'll see if Japanese policy makers are capable yet again of disappointing current position holdings so soon.

The Cyprus crisis has opened up some precedents that will make investors more worried about how future eurozone crises develop. According to the policy makers, Cyprus is a “unique” case – but so were Greece, Ireland, Italy and Portugal - to say nothing of Spain in the near future. The PIIGS and Cyprus are all unique according to most Euro-policy makers. The only thing that the EU has achieved with certainty this week with their “no new precedent” Cypriot situation is that European bank creditors or even depositiors are no longer sacred.

The Cypriot position is changing the EU rule handbook and allowing ‘traditional’ capitalism to work. With the stronger north taxpayer hesitating at the cost of rescuing their cash-strapped southern neighbors, policy makers have succeeded in placing the order of who loses out in a rescue, assigning risk where it belongs – investors, bondholders and eventually even deposit holders. If that is insufficient from preventing systematic risk, then taxpayers will have to share a portion of the burden.

The obvious downside is that some of the weaker Euro members will now surely become exposed to potential depositor flight risk. By default, this will push the already weaker financial institutions under further stress. In turn, this will only make financial institutions even more cautious, the consumer more nervous and the bank depositors a little more suspicious. A reaction like this will simply end up affecting growth rates across Europe, making it even a little weaker than before.

If bank creditors are to lose money it is has to be through a “fair and transparent structure” – hence the “no template” Cypriot template approach. This is the shot across the investor bow – buyers beware. This new basic credit write-down structure formula is also aimed to avoid using any EU bailout fund, like the ESM, to recapitalize banks.

The Cyprus fallout and the way it has been handled is a root problem for the single currency. If we were to add some not yet named troubled banks, any depositors with flight risk potential and ad-hoc policy making one should be wondering when and where the next phase of the euro-crisis would be.

EUR option barriers are plentiful this morning. The single currency is been strangled by option plays every 50pts below, while corporate EUR/JPY pair selling has managed to trigger the 1.2800 benchmark handle. More volatile price action can be expected as defense ahead of barriers is mounted below. Technically, downside EUR pressure should remain now that spot has broken below yesterday’s base low. Any intraday correction should be limited as more EUR offers dominate the topside. However, it’s a short trading week and the market follows liquidity.