Cyprus has become the fifth Eurozone country to apply to Brussels for an emergency bailout, after similar calls for help from Portugal, Ireland, Greece and Spain. Heavy dependence on the Greek economy has pushed Cyprus into this corner. The Cypriot banking sector is oversized for a country with only one million residents and it suffered badly from significant write-downs on Greek sovereign bonds. Cyprus hasn’t been able to access the debt markets since 2011 since being downgraded to ‘junk’ status by Moody’s and S&P, Fitch’s move to follow suit yesterday provided the final push to force the country into a bailout request.
In the very short-term, €1.8bn (around 10% of its domestic output) is required to recapitalise its second largest bank, Cyprus Popular Bank, while its largest bank, Bank of Cyprus has reportedly called for aid of around €500 million. Plenty more will be required for state financing and the country really requires a buffer from any further spillover effects from Greece.
The bailout is expected to amount to approximately €10 billion, which is equal to over half of the Cypriot GDP, currently standing at €17.3 billion. Along with the Spanish application for bailout funds for its banks, Cyprus’ bailout application has today been formally accepted by the Eurogroup. The funds will come from either the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM) when it becomes active. This comes after controversial but ultimately unsuccessful bailout negotiations with Russia and China. Dimitris Christofias, the Cypriot president, had expressed his wariness of the strict conditions that would come with an EU bailout. In particular, Cyprus’ rock bottom (10%) corporate tax threshold may be a cost of the bailout request. The terms of the bailout will surface in the coming weeks.
In terms of the impact on overall sentiment towards the eurozone, the Cypriot request for a bailout will not in itself weigh too heavily. Whilst it is another worrying example of debt contagion and does build on increasingly negative eurozone sentiment, Cyprus is the eurozone’s third smallest economy and this bailout request been a long time coming. Market nerves at the moment are more firmly fixed on the eurozone’s fourth-largest economy- Spain. The euro is posting significant losses across the board; the key EUR/USD pair looks likely to retest its multi-month lows of $1.2285 in the near future.
Adam Highfield
Analyst – Caxton FX
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Showing posts with label downgrade. Show all posts
Showing posts with label downgrade. Show all posts
Wednesday, 27 June 2012
Tuesday, 26 June 2012
Spain requests bailout and adds to the euro’s woes
Spain formally requested assistance from its Eurozone partners on Monday, in light of the continued deterioration of its domestic banks. Luis de Guindos, the Spanish Economy Minister, sent the letter to Jean-Claude Juncker, who heads the group of Eurozone finance ministers, in the hope of obtaining a bailout loan thought to be in the region of €100bn. However, a lack of detail over the size of the bailout is a source of considerable market uncertainty. The news was fully expected following weeks of speculation over the condition of Spanish banks, and following the first call for help on 9th June.
What is also a source of nerves is where the bailout funds will come from. The recent bank restructuring in Ireland could be used as a precedent, in which case the loans would be channeled from the existing bailout fund, the European Financial Stability Mechanism, into Spain’s Fund for Orderly Bank Restructuring (Frob), which in turn will direct the money to those banks that need it. In this model, the loans would rank equally with private bondholders. If the loans come from the European Stability Mechanism, the new bailout fund, they will rank as senior debt and with the Greek haircuts fresh in the memory, the result would be investors hitting Spain will higher borrowing costs. The former option looks to be the likely choice. Another key concern is that as the bailout loans are likely to be channeled through Spain’s government, this means adding billions to Spain’s sovereign debt and increasing the country’s debt-to-GDP ratio considerably (from 70% to 80%). Again, this will have implications in Spain’s credit rating and borrowing costs.
These two factors are already an issue; Moody’s has downgraded Spanish debt to Baa3 (one higher than ‘speculative’), as well as issuing 28 fresh downgrades to Spain’s banks yesterday. This has resulted in a rise in the yield on Spanish 10-year debt to 7%, the government appears to be edging towards a sovereign bailout. Whilst in the short-term a bailout of the eurozone’s fourth largest economy would be a huge source of huge panic, a Spanish bailout may be the kick that EU leaders need to finally break ground on a long-term path to solving the debt crisis. Only time will tell.
So how has the euro responded? The Greek election result provided only a temporary respite and with the ongoing issue of the Greek bailout renegotiation ahead Spain edging closer to disaster, market tensions are rising. The euro has suffered a downwards correction in the past few sessions, dipping from $1.27 to $1.25, and allowing GBP/EUR to climb from €1.24 to €1.25. We maintain a negative outlook for the euro.
The EU Summit at the end of this week provides ample opportunity to calm market nerves, though the track record of these crisis meetings producing major progress is not a good one. Merkel has been typically stubborn on issues such as mutualised debt (Eurobonds) and with the Greek PM ill, no progress is likely to be made on the Greek bailout issue. Decisions with regard to Spain will be crucial if stocks are to avoid a further sell-off and if building pressures in the bond markets are to ease. The euro could be poised for a move lower.
Adam Highfield
Caxton FX
What is also a source of nerves is where the bailout funds will come from. The recent bank restructuring in Ireland could be used as a precedent, in which case the loans would be channeled from the existing bailout fund, the European Financial Stability Mechanism, into Spain’s Fund for Orderly Bank Restructuring (Frob), which in turn will direct the money to those banks that need it. In this model, the loans would rank equally with private bondholders. If the loans come from the European Stability Mechanism, the new bailout fund, they will rank as senior debt and with the Greek haircuts fresh in the memory, the result would be investors hitting Spain will higher borrowing costs. The former option looks to be the likely choice. Another key concern is that as the bailout loans are likely to be channeled through Spain’s government, this means adding billions to Spain’s sovereign debt and increasing the country’s debt-to-GDP ratio considerably (from 70% to 80%). Again, this will have implications in Spain’s credit rating and borrowing costs.
These two factors are already an issue; Moody’s has downgraded Spanish debt to Baa3 (one higher than ‘speculative’), as well as issuing 28 fresh downgrades to Spain’s banks yesterday. This has resulted in a rise in the yield on Spanish 10-year debt to 7%, the government appears to be edging towards a sovereign bailout. Whilst in the short-term a bailout of the eurozone’s fourth largest economy would be a huge source of huge panic, a Spanish bailout may be the kick that EU leaders need to finally break ground on a long-term path to solving the debt crisis. Only time will tell.
So how has the euro responded? The Greek election result provided only a temporary respite and with the ongoing issue of the Greek bailout renegotiation ahead Spain edging closer to disaster, market tensions are rising. The euro has suffered a downwards correction in the past few sessions, dipping from $1.27 to $1.25, and allowing GBP/EUR to climb from €1.24 to €1.25. We maintain a negative outlook for the euro.
The EU Summit at the end of this week provides ample opportunity to calm market nerves, though the track record of these crisis meetings producing major progress is not a good one. Merkel has been typically stubborn on issues such as mutualised debt (Eurobonds) and with the Greek PM ill, no progress is likely to be made on the Greek bailout issue. Decisions with regard to Spain will be crucial if stocks are to avoid a further sell-off and if building pressures in the bond markets are to ease. The euro could be poised for a move lower.
Adam Highfield
Caxton FX
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