Monday, March 25, 2013

It's The Economy Stupid: Bridgewater & Zervos on Cyprus

Bridgewater Daily Observations

Cyprus: “To Kill a Chicken to Scare a Monkey”


Though the terms of the Cypriot deal have evolved from the beginning of negotiations until now and they will certainly evolve over the next few years, the overriding principle that has been followed and we expect to continue to be followed is that only systemically-important entities will be protected – i.e., that the Eurozone's plan for dealing with its debt crisis is a B1 type of plan. While this principle means long, depressed economic conditions in overly-indebted countries, it also means that the long-term risks of unmanaged debt crises and unacceptable inflations are reduced. It is in our view the best balance of the set of difficult choices.


Though there is considerable worry that not providing more support for Cyprus, especially if it means that bank depositors will be hit and Cyprus will exit the euro, will produce unacceptable results, we believe these concerns are exaggerated and that to allow them to drive policy would lead to bigger costs and problems down the road. As conveyed in the actions taken, the principle that the country having the banking crisis will be responsible for the financial consequences before the EU and ECB will be responsible will also be conveyed.



David Zervos, Jefferies & Co.

Bombs diffused, damage done, still hanging in the bunker


The Sunday evening Cypriot bail-in deal shows that the Germans are willing to go to great lengths to secure a political win. And let’s be clear, what was agreed last night was a HUGE win for Merkel. She silenced SPD critics on the issue of bailing out Russian oligarchs. And she looked tough on EMU countries that find themselves over their financial skis. It might have been better if she could have done this with only a month to go before the election; but hey, there are plenty of little countries in the zone for her to pick on as we head into the fall. What we have learned over the last week is that any small EMU country which does fall into line for the political gain of the north is expendable. These countries are all basically sacrificial pawns in a very complex chess game.


While the details of the deal are still sketchy, the most important part is that it does not hit insured depositors. Rather, the resolution of the losses will follow a traditional path of hitting sub/senior creditors and uninsured depositors. While some may applaud this result as “a win”, it is hard for me to be excited about someone doing the right thing. Are we really supposed to jump up and down and cheer that the Europeans did not randomly redistribute the capital structure of the Cypriot banking system. Pulllease! Just opening the discussion of hitting insured deposits, before wiping out the rest of the capital structure, is insane– I refuse to rejoice because they followed the correct legal structure when dealing with a priority of claimants on the banking system. 


As for the market reaction, it has NOT been painful to exit risk and sit on the sidelines for the last week: the Euro remains weak; the Yen remains strong; Treasuries trade within last week’s ranges; and Bunds trade amazingly well. Finally, as I sit here and watch spoos bounce around 1555/1560, there is NOTHING about the price action that makes me want to buy. In fact, it feels quite easy to be in the bunker with nothing on the books. For me, it is more tactical than fundemental. We have been pounding the table for risk-on all year (and certainly alot longer than that). We told clients to ignore the sequester and Italian election results with good results. And heading into this Cyprus mess the spoo was +10 ytd and nky was +20 ytd. Its been a great start. Why play with an extremely hard to value tail situation. If you miss 1 to 2 percent in risk because it all calms down then so be it. You are still dealing with a 20 to 30 percent chance of material set back. I just don't like the odds with the market at the highs.


And furthermore, I think the market is WAY too complacent on this one. Bank runs are the scariest phenomenon in financial markets. We don't have any idea how to model or predict them. And we have had limited success stopping them. I would rather watch the banks open in Cyprus and see how the deal evolves before making any BTD recommendations. Good luck trading.

























John Broussard

Assistant State Treasurer

Chief Investment Officer

State of Louisiana

Department of the Treasury

Ph:  225-342-0013

Fx:  225-342-9721


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Baton Rouge, LA 70802

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Exit 1B I-110 Convention Street,

Turn Left to get to North Blvd,

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