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Cyprus Rejects Bailout Agreement; Fed to Continue Buying Bonds

Market Digest – Week Ending 3/22

Tiny Cyprus captured the spotlight when European finance ministers announced a plan last weekend to tap into personal bank savings accounts to help cover bailout costs. The proposed strategy provoked outrage and put a dent in the recent stock market rally. Banks in Cyprus remained closed, with the government scrambling Friday to reach an agreement to prop up ailing banks and keep the country in the Euro. US stocks regained most of the early week losses on optimism the turmoil would not spread to Spain or Italy. Treasuries rose as Bernanke said the Fed would continue its bond buying program for now and would vary it based on the economy. This means a sudden stop of bond purchases in 2013 is unlikely.

Weekly Returns:

S&P 500: 1,557 (-0.2%)

MSCI ACWI ex-US: (-1.4%)

US 10 Year Treasury Yield: 1.91% (-0.08%)

Gold: $1,607 (+0.9%)

USD/EUR: $1.299 (-0.6%)

Major Events:

  • Monday – Cypriots expressed dissatisfaction with a plan to tap their savings accounts as part of the countries bailout and the government attempted to create a revised approach.
  • Tuesday – Cyprus’s parliament rejected its government’s bailout agreement with the Eurozone without a single yes vote.
  • Wednesday – Fed Chairman Ben Bernanke said the central bank will vary its purchases depending on how the economy is performing.
  • Thursday – A composite based index showed Euro area services and manufacturing shrank at a faster pace than expected in March.
  • Thursday – The ECB said it would only extend until Monday emergency funding which has kept Cyprus’s banks afloat.
  • Friday – Nike, Tiffany and Micron all reported better than expected earnings.

Our Take:

It is a dark time in Europe when the idea of simply taking a portion of people’s bank deposits is championed by the major forces that be. For the people of Cyprus, it may actually be preferable to other likely alternatives, including leaving the Euro, but this is beside the point. What matters to US investors is if depositors in Italy and Spain decide their money is no longer safe in their own banks.

Even if Cyprus resorts to bank “haircuts”, we doubt it will lead to bank runs elsewhere. The prevailing attitude is that Cyprus is a small and unique case. But we can’t rule it out. Coupled with more reports of economic shrinkage, risk in Europe is rising.

It’s hard to be optimistic on the mid to long term future of Europe. Tucked under the Cyprus headlines this week was a debate surrounding European Parliament and caps on bonuses for fund managers at 100% of base salary. While not meaningful on its own, such rules are symbolic of what is wrong in Europe. Free markets should dictate compensation, not governments. In this case, companies will simply raise base salaries, giving them less flexibility when times are tough.

European leaders made a mess of their balance sheets, but took reasonable action to get the situation under control. Now they must move toward greater economic efficiency if they are to find the growth they so desperately need. Sometimes government intervention is needed, but too much government is what got Europe into its current mess. Adding more will ensure it does not keep up with the US and Asia, both of which appear to be accelerating.

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