Many have noted the fairly muted market reaction to the crisis unfolding in Cyprus.
At a press conference Wednesday following the Federal Reserve’s regular FOMC policy meeting, Fed Chairman Ben Bernanke nailed the general mood, telling reporters:
[Cyprus] does have some consequence. But having said that, you know, the vote failed and the markets are up today, and I don’t think that the impact has been enormous. I mean, I think it’s something we’re paying attention to, and we hope that the Europeans will come up with an efficient and equitable solution. We are monitoring very carefully, but at this point we’re not seeing major risk to the U.S. financial system or the U.S. economy.
Société Générale credit strategist Suki Mann attributes the market’s general lack of interest in the Cyprus situation partly to Bernanke himself, as well as his fellow central bankers around the world.
For Mann, this episode just reinforces the theme that fund managers’ ongoing “search for yield” is still the overriding factor driving markets, at least for now.
However, Mann still wants to sit this one out. In a note, he writes (emphasis added):
Fantastic. The market reaction to the crisis in Cyprus. There is no other way to describe it. Peripheral government debt is holding firm, equity indices have zoomed past the moon, safe-haven bonds have rallied (just in case) and corporate credit walks on by, merrily. It’s one thing injecting massive liquidity into the global financial system allowing for easier refinancing of obligations across all parts of the economy, ensuring easier debt servicing and sustaining a low default rate in the midst of a great economic downturn.
It’s another when we almost completely ignore Cyprus, its potential for a eurozone exit and the non-trivial probability that such an event would unleash massive contagion. We’ve been here before many times over the past few years, a ‘solution’ has always been found. But the brinkmanship is at a new level, the political will to help do whatever they have to is more questionable and, into it, the Cypriots are gambling on receiving 93c on the dollar (original deal) versus losing say 93c (if it all collapses).
Liquidity hides many ills, but is the power of zero (returns from cash) that great? In credit, we buy risk where the corporate entity is in fundamental decline. We become yield hogs and add paper that we would never dare look at previously. Ratings downgrades (and transmission risks) do not matter. As long as the potential for default is very low, the yield of the product wins out.
There’s been massive manipulation of the markets, it’s given risk asset performance a huge boost for the best part of nearly two years, and we are sure there’s more to go. We are, after all, in Japanification territory. Right now, our concerns mean we’d be sidelined until the Cyprus situation plays out. Most are anyway.
Fellow SocGen analyst Sebastien Galy said this morning that there is concern about a last-minute Cyprus deal leading to a “brutal short squeeze.” Read his take here >
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