Bond Outlook by bridport & cie, March 27 2013

The Cypriot crisis is centred on the country’s banks, rather than government debt, and is thus closer to the problems previously seen in Ireland than the other peripheral nations. An important difference however with the Irish situation is that the Irish Government assumed responsibility for their banks’ debts. The Cypriot crisis is indeed therefore unique, with a special bail-out structure, and its own particular set of implications.

The first implication is that a banking crisis is actually easier to deal with than a sovereign debt crisis. Banks can be allowed to fail, whereas a sovereign debtor cannot go bankrupt as such, and has to turn to austerity and to rebalancing national budgets, which take years. This probably explains why Ireland is the first of the peripherals to have more or less succeeded in returning to a semblance of budgetary balance.

The second is that the principle in Europe of protecting depositors at all costs has just been abandoned. Our first reaction to the confiscation of deposits in Cypriot banks was that to undermine confidence in banking was the last thing an economy needed. At least the bail-out plan does not touch deposits up to € 100,000. Over that level, however, the losses for depositors will be heavy.

The third implication is that we would now question whether a euro deposited in a Cypriot bank can be valued on a par with other euros, given that its transferability is now impeded, and, should it be part of a large deposit, that it may be subject to confiscation.

Our initial reaction to the potential seizure of a percentage of larger deposits was overtly negative (given the implications for a loss of trust in institutions across the region). However, we acknowledge that there are positive aspects that may emerge from this decision.

Jeroen Dijsselbloem, Dutch Finance Minister and President of the “eurogroup” of euro zone finance ministers has put firmly on the table that depositors will be vulnerable in the event of banking failure, and whilst this may have initially sparked criticism, his view has gained support, including from the influential Financial Times.

The FT argues that removing automatic protection will oblige depositors, or at least the large ones, to look much more closely at a bank’s solidity before committing funds, greatly encouraging more conservative management of both parties. The new paradigm is remarkably similar to the USA’s FDIC system. When banks in the USA fail, deposits up to $ 100,000 are protected, whilst those over that sum are not.

Whether deposit insurance is wise or not is currently being debated, not least in the UK. Two years ago the Government announced their intentions to “ring-fence” retail banking from investment banking. So little progress has been made, and so great has been the opposition, that we suspect the plan is being quietly dropped. A major argument of opponents to the plan is that the failures of Lloyds, RBS and Northern Rock were attributable to retail banking, rather than the perceived higher-risk attributed to investment banking operations.

We wish our readers a Happy Easter. Caroline Weber will preparing the next Weekly and Roy Damary will be back in a fortnight.

Macro Focus

United States

The leading indicators climbed 0.5 % for the second straight month in March. Orders for durable goods rose 5.7%, the most since September, propelled by automobiles and commercial aircraft.

Manufacturing in the Philadelphia region expanded following the example of factories in the New York region.

Americans bought existing homes at the fastest pace in three years in February as borrowing costs near record lows spurred a housing revival that may boost economic growth this year. Residential real estate prices climbed 8.1 % from the same month in 2012.

Eurozone

Euro-area services and manufacturing output contracted from 47.9 in February to 46.5. German manufacturing output declined from 50.3 to 48.9, while the services gauge fell from 54.7 to 51.6.

The German indicator IFO declined from 107.4 to 106.7. Both components, current assessment and expectations, were down.

The new government in Slovenia, member of the euro zone, has promised to recapitalise its banks.

United Kingdom

Retail sales rose in February in a rebound from the previous month when heavy snowfall held back consumers. Sales surged 2.1 % from January and 2.6 % YoY.

House prices rose the most in three years this month, led by a surge in London. Average values in England and Wales increased 0.3 %, while in London prices jumped 0.7 %.

Britain had its smallest budget deficit since 2008 after the Treasury received a second instalment of cash from the Bank of England and proceeds from the sale of fourth-generation mobile spectrum. The shortfall excluding temporary support for banks was £ 2.76 billion compared with £ 11.76 billion a year earlier.

Switzerland

In February, the trade surplus shrank to CHF 2.1 billion from a revised CHF 2.12 billion in January. Exports declined 2.6 % from January, and imports fell 5.4 %.