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As Cypriots lose faith in politicians, so do speculators in the Euro

FXstreet.com (Barcelona) - The financial paralysis in Cyprus continues to be the primary theme around global markets, with the Euro suffering a well deserved punished, after the infamous bank deposit levy on Cypriots failed to be ratified by the Parliament.

The country remains in financial paralysis, with politicians having had to resort to an undefined bank holiday period, first since the crisis started in 2007. The volatile situation suggests the Euro looks poised to more headwinds until further clarity.

The consequences for the shared-currency so far were a new fall to print fresh year lows below 1.2875 until bottoming out at 1.2844 as traders realized that the plan "A" in Cyprus had been rejected, implying that an alternative way of solving the banking crisis now has to be found. In the next few days, nobody knows for certain what the next action taken will be.

For now, the ECB said "it reaffirms its commitment to provide liquidity as needed within the existing rules", and that "it takes note of the decision of the Cypriot Parliament and is in contact with its Troika partners” from the International Monetary Fund and the European Commission", according to a statement.

In view of Richard Kelly, Head of European Rates and FX Research at TD Securities, "their first alternative is to try to negotiate Russian support on Wednesday to see if they can get a better offer on existing loans or negotiating power with the Eurogroup, however, Cyprus has little leverage with either."

The opposition by the Cyprus Parliament to the 'legalized robbery' aka tax on citizens' deposits, so that the government can obtain the remaining €5.8bn of bailout funds, "puts Cyprus on the hook for €30bn instead, the math that makes a hard bank default difficult to fathom, but the downside risk that the no vote has now opened up for Cyprus nevertheless" adds Richard.

Today, the focus is likely to be on the sense of urgency to find a prompt and workable solution for Cyprus —days or weeks? "If the former, the ECB should be willing to roll the emergency liquidity assistance program" Richard adds.

Another dangerous front that the Cyprus crisis opens up is how to intelligently shift the tide of events developing, so that the Euro area can maintain depositors' confidence in the banking sector across the region amid the impractical handling of the Cyprus banking crisis and the lies on what is supposedly a wide insurance mechanism on saving below €100,000.

According to Nomura economist Jacques Cailloux, the new challenge faced by the Euro now is "exiting successfully from the bank holiday and maintaining confidence in the wider system across the rest of the euro area", something he assesses as not an easy tasks and might require some “credible regime-shifting policies”, and he compares the present status with lessons from Roosevelt’s ability to bring about a complete turn in confidence after the March 1933 - Bank Holiday in the US.

At the time, the conditions to restore confidence in the banking sector after a run, as Jacques describes, were: "(i) eradicating doubts that losses on deposits will occur; and (ii) a regime shifting policy response which in the case of the US was the Emergency Banking Act later followed by the FDIC. But Jacques sees "transposing this framework to the euro area and to Cyprus in particular it seems very hard to meet those conditions in the short term."

The Nomura economist argues that the damage has already been done, adding that the sense of fear to Cypriot depositors deposits no longer being safe even under a presumed guarantee policy is a battle that Euro leaders seems to have lost, one that may have far-reaching consequences beyond the diminutive Cyprus borders.

"Offering a new insurance contract when the house has been burnt and the previous insurance did not cover for the damage is no great way to regain confidence" the Nomura economist says.

Looking at the EUR/USD prospects, the pair has been absorbing what little demand was left through 1.2900 to establish fresh bear trend lows, and in the process, remains the fact that Monday's gap was only half filled, a sign of few unwilling buyers.

As perceived by Chris Capre, founder at 2ndSkiesForex: "Intraday resistance comes in at 1.2890, 1.2920 and 1.2950 where the impulsive selling started. Thus, look to sell on any corrective pullbacks into those levels, targeting a much deeper sell-off towards 1.2690 and potentially 1.2400 should the situation in Cyprus deteriorate further."

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