The Cyprus deal does not look to be taken by the market well, with the EUR down to a variety of currencies and the US markets dropping until the ECB spoke in the early afternoon about providing liquidity to the banks. This will no doubt have the week fraught with volatility and see great opportunities to make and lose profits. Therefore I have lowered my overall positions to the Euro with a third in negative correlation plays and the rest in positive.
I believe that, despite the ‘good news’ in the near term about the Euro, until there is a true move towards growth (read stimulus) there will be more Cyprus incidents in the future. With the precedents set now this could make the Euro decline more as both speculative and non-speculative capital start to worry about holding cash in the region, the positive correlation plays are here for the time being.
The Euro zone is back in the headlines with the Cyprus bailout taking a turn for the worst. The decision to levy the deposits on bank deposits has cause a panic in the country, as well as creates a dangerous precedence in the euro zone bailouts. This has cause the short position that I have on the Euro to make strong gains at the open (with the EUR/HUF short as the exception) and I have put in some stops in the event that there is a strong rally back overnight. I am still net short the Euro to a variety of currencies the majority of which are positive correlation plays*, as this plays out I will look for an opportunity to add to the negative correlation plays as the EU leaders hopefully recognize the situation and take action.
* notes to an article that I am in the prosess of writing about the Euro short play:
The National People’s Congress is in session and much of the talk is about reform (including the dampening of property prices and changing the country over to a consumer driven, not export driven, economy) among other issues such as pollution and unrest. The cure for many of these reform issues could be tackled with an opening of the economy allowing capital to flow freely into the country as well as out of it. Short of any illegal means (think Macau) the investment landscape is narrow for wealthy Chinese to invest. This causes bubbles to form among assets and more severe boom bust cycles as a result; by allowing money out of the country to seek diversified returns there will be less need for the investment into real estate when other markets are underperforming, therefore seeing prices go down. With the average home mortgage in China being 40 years of earnings and over 50% of their disposable income (the US average is around 10%) there is little room to start a consumer driven economy. Home owners (not speculators) will need to see the equity in their home rise at a faster rate in order to feel better about spending discretionary money. In order to keep assets from increasing you will have to take the speculative aspects from the markets by providing more options. Increasing the percent down on a home and stemming lending is not discouraging the wealthy investors, but rather making the dream of home ownership on the middle class that you are relying on to spend, more difficult.
This will cause the homebuilders to take a hit as their assets drop from their lofty highs, causing the homebuilders to experience more of the drops they have seen recently. This could provide a silver lining as well by discouraging those companies from seeking more government land grabs as profit potential drops and inventories rise (one less thing to protest about).
The Euro has declined rather steady over the past month, briefly dropping below the 1.30 mark, from the combination of poor economic news and the lack of a clear victory in the Italian election. Looking at the longer term factors this could set the stage for the ECB to look at making their currency more attractive to borrow in. In short, lower interest rates and become a funding currency. This would provide two functions, should it occur.
First, it would be the most feasible politically. By lowering rates the ECB can avoid the hassle of the EU countries to come to some sort of agreement on the ability to implement a simulative plan. With lowering inflation figures coupled with lower commodity prices; it will also be within the mandate of the ECB without the threat of inflation breaking above the 2% level.
Secondly it will make the availability of loans more accessible through lending from banks now that the risks have subsided in many regions of the bloc (as seen by the relatively small move in yields on Italian bonds after the election). This will also help to create a pro growth agenda without having the budget, or political power in Brussels to achieve this goal.
I do not think that the ECB meeting this Thursday could produce a cut in rates, but the language might hint towards the possibility of lower rates in the future. As a trade I am putting on diversified currency pairs to the Euro to both play the drop and over a longer term collect roll on the interest rate differentials that exist.