Cyprus Contagion?

BarroMetrics Views: Cyprus Contagion?

So, Cyprus has voted to reject the bailout terms.

Now ECB has a problem. Will it allow Cyprus to go under or will it change the terms of the bailout? Either move is fraught with with danger for the ECB.

Allowing Cyprus to go unaided, means it will leave the Euro. This could be the start of the end for the Euro; an end Draghi vowed the ECB would do whatever it took to prevent. And, there is also a small risk of contagion. 

Right now there appears to be a firm belief that Central Banks can defy the economic laws and keep stock markets afloat through the ‘printing press’. If this sentiment is shaken and lost, the FED, ECB etc will have run out of ‘magic pills’. For this reason, we can imagine that the ECB will be tempted to change the bailout terms.

BUT….

…..the ECB then faces the problem that it blinked. This will make it that much harder for it to impose the conditions it wants in future negotiations. I can’t see Germany coming to the party on this one. Still, I have been known to get it wrong (ha-ha).

So far the S&P’s reaction has been mild. Figure 1 shows Tuesday, Mar 19’s price action: we see below average volume and average range. Not the sort of bar that suggests the presence of contagion.

In my view, Cyprus may spark a correction; but unless there is another shock, not the event the is likely to cause a change in sentiment. So, more grinding upside in the S&P, but the storm clouds are gathering.  

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FIGURE 1 S&P Daily

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