What Next?

The global capital markets have reacted calmly to the Cyprus rejection of the terms of the 10 bln euro aid package. There is an ECB meeting today, which the Cyprus central bank governor is not attending. The immediate issue is that without an agreement should the ECB continue to allow Emergency Lending Credit be extended to Cyprus banks. It had previously threatened to cut it off as of tomorrow. This was the hard place on the other side of the rock of the conditionality which included a tax on all depositors that Cyprus found itself in over the past weekend. 

When the post mortem of the Cyprus debacle is conducted, the failure to include Russia, an important stake holder in the talks was an important blunder.  Although Cyprus is making overtures now, European officials will not accept new loans from Russia to meet its 5.8 bln euro funds it needs to raise.  That would, after all be counter-productive putting the country back on a sustainable fiscal trajectory.  

While the ECB has a difficult and, one might add, a fundamentally a political not a technocratic, decision.  Cyprus needs to quickly propose an alternative.  Selling exploration to the gas fields on its continental shelf to Russia's Gazprom as some have suggested would seem to be tantamount to surrendering sovereignty in the other direction.  The bank holiday will be extended and reports now suggest they might not re-open until the middle of next week.  

In addition to the Cyprus developments, there are several other events vying for attention.  First, the UK budget is awaited and there is some thought that the BOE's remit may be modified, in order to give monetary officials greater leeway to offset the austerity that the Osborne is expected to maintain.   

Sterling had been under performing, but the MPC minutes showed that King and his two allies (Miles and Fisher) failed to carry a majority for the second consecutive month to resume gilt purchases.  The majority was concerned about the credibility of the BOE on new gilt purchases.  Gilts sold off  as many suspect that the window to resuming QE is closing as to avoid forcing Carney to inherit ongoing operations; better to begin with a clean slate, so to speak.  

Sterling rallied a cent against the dollar to new highs on the day, just above yesterday's peak near $1.5145.  Nearby resistance is seen in the $1.5160-80 area.  The UK's employment data failed to impress.  The jobless claims fell by 1.5k instead of the 5k the consensus expected.  The unemployment rate was steady.  Of note, the average weekly earnings slowed to 1.2% (Jan 3m year-over-year) compared with 1.5% expectation, which is well below levels that the BOE has indicated are consistent with price stability.  

The FOMC meets today.  It will provide updated macro-economic forecasts.  The statement will not go into details about the evaluative discussion QE and a review of the exit strategy.  We suspect that this is going to be more the focus of Bernanke's press conference. 

The Fed is likely to recognize that the recent string of economic data has been encouraging in terms of the resilience to the fiscal headwinds, though in other regards, we don't expect substantial changes in the statement.  

On the other hand, it may revise it GDP forecasts lower.  Recall that the the mid-point of its range for 2013 is 2.7%, which as is its habit, on the optimistic side.  The Bloomberg consensus is 1.9%, which is the same as the Philly Fed's survey.  The National Association of Business Economists is 2.4%.  Forecasts of inflation (PCE deflator) and unemployment are unlikely to be altered much.  

Lastly there are two notable developments among the Antipodeans.  First is the forecasts for iron ore prices.  One major investment house cut their forecasts to $139 a tonne from $144 average for this year.  The main considerations were moderating demand in the face of softer steel production in China.  In contrast, the Australian government raised its forecast to $119 from  $106 a tonne forecast last December.  Separately, Australia reported a 1% decline in merchandise imports.  We suspect that poor weather and the Chinese New Year distortions have skewed the data. 

Second, New Zealand reported another sharp jump in milk prices.  The 14.8% rise at the fortnightly auction follows a 10.4% rise at the previous auction.  The key whole milk powder jumped 21%.  However, the rising price is to distribute the drought-induced scarcity.  Volumes fell by 28%.   New Zealand reports Q4 12 GDP early in Wellington on Thursday.  After today's somewhat wider than expected Q4 current account deficit, the risk is slightly to the downside of the 0.9% consensus forecast.