Market Update

Like a not-quite-dead villain in a horror film, the Eurozone crisis raised its ugly head again last week, scaring investors and causing many stock markets to close flat or slightly down for the week, according to Barron’s. Investors’ worries strengthened demand for Treasuries, pushing the yield on the benchmark 10-year bond lower.

In Lexington’s opinion, the hero of last week’s drama might have been the United States which delivered a plethora of stronger economic data that included a steady decline in unemployment claims, an increase in factory activity, and a rise in existing home sales. The positive news suggested that the U.S. economy was gaining momentum. In addition, Federal Reserve Chairman Ben Bernanke reiterated the Fed’s commitment to accommodative monetary policy. He set the expectation that short-term interest rates will stay at exceptionally low levels until unemployment falls to 6.5 percent. Some believe that could happen in 2015.

Lexington saw that signs of strength in the U.S. economy were overwhelmed by another crisis in the Eurozone. This time the issue was Cyprus, an island nation that accounts for a tiny portion of the Eurozone’s economic production. Cyprus has relatively robust growth and boasts a small budget deficit, so why did it ask for a bailout? According to The Economist, the issue is the country’s banks are bigger than its domestic economy. Since a bank deposit guarantee is only as good as the country providing it, Cyprus needed assistance. Cyprus is a microcosm of the Eurozone which has about “€8 trillion of deposits and only €4.5 trillion of annual government revenues,” according to BCA Research cited in The Economist.

Eurozone leaders responded to the Cypriot bailout request by suggesting the country impose a tax on bank deposits. The Cypriot parliament rejected the suggestion and the European Central Bank responded with an ultimatum: accept a bailout by Monday or else. The government’s decision will affect Cyprus’ largest banks and, possibly, the country’s participation in the Euro.

As this was being written Cyprus agreed a deal with the European Union and the International Monetary Fund (IMF) to secure a 10bn euro bailout. It came just hours before a deadline set by the European Central Bank (ECB), and after a week of uncertainty about the future of Cyprus in the Eurozone.