The biggest source of uncertainty from the Cyprus bank bailout deal this week is whether the government can get it through parliament.
The deal, which features a controversial haircut for depositors, is being revised to make it more progressive, so that the burden of the haircut falls more heavily on those with bigger bank accounts.
Still, people are angry, and understandably so. Meanwhile, the new haircut distribution doesn’t raise the total 5.8 billion euros that the EU demands Cypriot depositors chip in to the bailout.
That’s why everyone is watching to see what happens in parliament this week.
BNP Paribas rates strategists lay out two scenarios for markets: one if parliament passes the deal, and one if it doesn’t.
(1) Cypriot parliament rejects the plan: the risk-off mode surges
Direction: We would probably see a strong rally in the Bund. We would expect the 1.30% level to be rapidly reached and maybe broken, with the risk of an extension closer to last year’s lows of 1.20-1.25%. Massive selling pressure on the peripherals would materialise, with higher yields across the board. A return to the 5.25-5.50% (10y BTP), 5.50-6.00% (10y Bono) and 7.00-7.50% (10y PGB) areas could be expected.
Curve: A flight-to-quality-driven rally is usually linked to steepening pressure. However, this would probably be more limited at the current levels of yield on short-dated German paper. A break through 0% on the 2y Schatz would be likely, as the contagion risk effect would cause the embedded FX option (eurozone break-up) to be partly priced in. This should not prevent the German curve from flattening. The move could be similar and even more pronounced in swaps, with more widening pressure on 2y swap spreads than on 10y swap spreads. In the peripherals, the reaction would probably be bear steepening, as the short ends should benefit from the protection of potential ECB support if the situation worsened.
(2) Cypriot parliament accepts the plan: Risk-off mode eases slightly
Direction: We would only expect a very limited setback in core markets. As long as Cypriot banks remained closed, the risk of a bank run will remain elevated. This would offer core EGBs solid protection very near term. Peripherals would recover, but as the deterioration in Italy and Spain would be very limited, we wouldn’t expect a decent rally.
Curve: A limited bear steepening in the cores and a limited bull flattening in Italy and Spain. Once again, because of the lack of reaction in both countries so far, any correction would likely be limited as well.
It’s unclear when a vote will be held.
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