Stability premium favors U.S. dollar

The U.S. dollar increasingly looks like an island of tranquility surrounded by a sea of global instability and uncertainty with the Eurozone once again in turmoil and with concerns over Asia and the Middle East. A continuation of these negative trends should be supportive for the U.S. dollar for the rest of the year.

The soon to depart governor of the Bank of England, Mervyn King, speaking at the London School of Economics this week, presciently remarked that “whichever crisis we are talking about it is far from over” adding that there are likely to be more unexpected twists and turns.  

The crisis of the moment is of course the Eurozone with Cyprus agreeing at the last minute to a €10 billion bail-out in exchange for raising €5.8 billion itself along with some unpalatable and worrying measures.

EUR/USD – twisting on the ropes again

Among the measures, which could come back to haunt the Eurozone, is the fact that depositors with more than €100,000 in banks in Cyprus face some form of expropriation to help fund the bailout.

There may be no obligation to guarantee deposits above €100,000, but it does set a worrying precedent for future rescues at a time when questions are once again being asked over the survival of the euro.

Jeroen Dijsselbloem, the Dutch finance minister who heads the Eurogroup, and played a key role in the Cyprus negotiations, suggested that the Cyprus bailout could form a template for future rescues, in other words depositors are now potentially fair game.

On top of that, capital controls will be imposed in Cyprus, necessary to stem the flight of capital spurred on by the expropriation measures, but nonetheless this feeds the fear narrative spooking the markets at the moment. It is highly likely that other Eurozone countries will need rescuing and the Cyprus example could make that task a lot more difficult as investors will have good reason to fear for the safety of their capital.

Without resolution there is plenty of downside for EUR/USD with support zones around 1.2700 and  1.2400 looking likely to be tested. However, if Eurozone policy makers can bring about a temporary reprieve it could see EUR/USD move back toward levels around 1.3000. 

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