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How The Cyprus Bailout Will Impact Forex Trading

March 25, 2013
Investing, Investments
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We finally got there: Eurozone and Troika ministers have agreed upon a €10billion Cyprus bailout plan at the second time of asking.

The important new clause in the deal is that all bank deposits under €100k would be protected and transferred to the designated “good bank,” or the Bank of Cyprus.  Larger deposits and underperforming loans will undertake a resolution process at Cyprus’ second largest bank, Laiki, which is to be set up as a “bad bank” under reforms put forward by the Troika.  This is a marked improvement for the regular Cyprus citizen, many of which withdrew their holdings from banks last week on the news that all deposits were to be effectively taxed, under the bailout conditions.

This article details what to expect in forex markets and why.

How Currency Markets Are Responding

Despite the footage of people queuing for days at cash machines around the small island to withdraw their savings, the Euro performed relatively strongly in the currency markets.  The 200 DMA of 1.2870/80 was defended last week, for example.

We saw a similar show of support on Sunday, with the Euro dropping during the European open after reports were showing that a bailout agreement was not on the horizon.  Cypriot President Anastasaides was even threatening resignation if no terms were agreed.  However, the dip only ever reached the 1.2940 level and a rally was quick to follow on the positive bailout news in several Euro crosses.  EUR/USD was tempered somewhat by traders fading the rally at 1.3050, but support for the single currency was certainly shown.

Looking Forward: What to Expect in Forex Trading

All of which begs the question: Will the Cyprus bailout bring back meaningful levels of volatility in the Forex market? And if so, what can we expect?

It’s our opinion that any confidence in the market will likely be short-lived.  While we have reached a resolution, the whole process of getting to this point was a bit of a farce.  Despite the repeated message that Cyprus is just a “one-off” case, the site of the bank run and the precedent that was set regarding possible bank deposit taxes is likely to temper investor confidence for a while at least.  Such risk-averse sentiment is likely to affect the Euro in several crosses; perhaps as well the AUD.  The apparent speed at which a deposit insurance policy was agreed upon for the Cyprus bailout is likely to leave investors wondering if the same policy will apply to the somewhat inevitable Spanish and Italian bailouts.

The bailout deal has the potential to open a can of worms that could stifle any risk-sentiment for months to come.  While the deal does not involve taxing depositors in general, we may very well see such a method in the future, particularly given the strong rhetoric German ministers were giving over the last few weeks and, as we all know, the German paymaster often gets its way.  Indeed, shares in Spain’s Bancaria bank have already taken a dip in Monday’s trading, while there was a pessimistic warning from Moody’s on the credit ratings of some French banks.

The precedent that has been set regarding the consideration of banking depositors means that investors are likely to ignore the talk of Cyprus being an isolated incident.  When the Spanish and Italian banks inevitably need help, investors could be forgiven for thinking that the same medicine will be administered there, prompting another bank-run.  With such lingering doubts handing over risk sentiment, we will likely see the EUR/USD pair below the sentimental 1.3000 level for the time being at least.

Initial support for the pair lies at 1.2980, with a sustained break below leading to a test of 1.2920/30 with stops below for 1.2840 area. From there on, it’s a one-way mission to 1.2660/90 lows, last seen in mid November last year.

Should the optimism remain in the Forex market, further consolidation in the 1.2980 to 1.3050 range may instil some confidence for a test above 1.3050/60, which would open up technical resistance level at 1.3130 (38.2% retracement). Above here stops are reported circa 1.3160 and a decisive break could see 1.3390/00 in play.

By guest contributor Richard Wiltshire, Chief Foreign Exchange Dealer at ETX Capital.

Disclaimer: The views and recommendations in this piece are held by the individual contributor and do not necessarily reflect the opinions of NerdWallet as a whole.



Cyprus bank image courtesy of Paul Cowan, Shutterstock.