Tiny Cyprus is getting a lot of airtime today as the Mediterranean island nation’s bailout has brought back the festering Euro-zone issue to the front. But I seriously doubt if it’s about Cyprus or the Euro-zone. We have had some really impressive gains in the market and investors seem to be using Cyprus as an excuse to prudently cash out some of those gains. After all, hardly anyone expects this week’s Fed meeting to provide any tangible signal about the course of their policy. And there is not much on the data docket other this week other than the Fed meeting.
The Cyprus bailout breaks new ground by forcing pain on bank depositors. But this is essentially a reflection of Cyprus’s unique bank depositor base (a lot of Russian money is parked there) and not a new template that would be relevant to the likes of Spain and Italy. No German politician would like to be accused of using tax-payer money to bailout (shady) Russian depositors. Outside of Switzerland, no such issues exist, particularly in Spain and/or Italy. As such, the odds of fresh financial market contagion as a result of the Cyprus issue are very low.
The Fed’s official post-meeting statement is unlikely to point towards a change in policy, though one would expect some acknowledgement of the recent flow of positive economic data. If not in the official statement, then the accompanying forecasts would indicate how the Fed officials view the interplay of recent positive data and the potential drag from fiscal austerity. Economic data has been turning up lately, prompting many to raise their forecasts for the current quarter.
But we have seen such favorable momentum at the start of the year lose ground in the Spring/Summer months in each of the last three years. May be ‘this time is different’ given the housing situation and stabilized European backdrop (Cyprus notwithstanding). Hard to know at this stage whether the ongoing improving trend will prove more enduring this time around or not, but it is no doubt reasonable to be a bit skeptical of blindly extrapolating recent data into the coming quarters. What all this means is that the Fed's QE program is here to stay, at least for now.