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Cyprus Relief: Why the Rally May Be Short Lived

Michael Sarris, Cyprus's finance minister, listens during a news conference following the Eurogroup meeting in Brussels, Belgium, on Monday, March 25, 2013.
Jock Fistick | Bloomberg | Getty Images
Michael Sarris, Cyprus's finance minister, listens during a news conference following the Eurogroup meeting in Brussels, Belgium, on Monday, March 25, 2013.

An eleventh-hour deal to resolve Cyprus' financial crisis helped Asian and European markets higher on Monday, but analysts warn that "risk-on" may be short lived, with downside risks remaining.

The rally came as Cyprus secured a deal with the so-called Troika for a 10 billion euro ($13 billion) bailout. The proposal also includes a levy on uninsured deposits over 100,000 euros in the Popular Bank of Cyprus, known as Laiki, the country's second biggest bank, which is set to be wound down.

(Read More: Cyprus Clinches Last-Minute Deal to Secure Bailout)

Japan's Nikkei rose 1.7 percent on Monday while Seoul's Kospi and Australia's benchmark S&P ASX 200 closed off earlier one-week highs. In Europe shares bounced back after last week's dip with all bourses opening higher. France's CAC 40 led the relief rally posting gains of 1.28 percent in morning trade.

Futures pointed to a positive open for U.S. stocks and market watchers were ready for the S&P 500 to break above its all-time high once again.

"I think the rally could last for the first half of the week and the S&P 500 has the potential to reach its all-time high." Ishaq Siddiqi, market strategist at ETX Capital told CNBC.com.

Marshall Gittler, head of global FX strategy at IronFX said if the S&P 500 continues to rise at this year's trend rate, it should break the record on Thursday.

"Relief over the Cyprus deal – plus an agreement on the U.S. budget, which seems to have gotten lost in all the excitement over here – could mean it hits that level even earlier," he said.

A budget plan was narrowly passed by the Senate on Saturday morning. It seeks to raise almost $1 trillion in new tax revenues by closing some tax breaks for the wealthy. The move could temper investor concerns for now, but an anticipated summer showdown over raising the debt ceiling is likely.

Analysts were not convinced however that the rally would last much longer than three or four days.

Head of trading at ETX Capital, Joe Rundle told CNBC Monday the Cyprus deal was "unpalatable" and the last week has left markets feeling nervous about the threat of contagion spreading across weaker euro zone nations.

"Markets are welcoming the news but this rally is likely to be short-lived with the attention likely to re-shift again to the prolonged political uncertainties in Italy, a country that remains ungovernable," he said in a research note.

(Read More: Where's the Long Awaited Market Correction?)

"Markets clearly appear to be more hopeful than they ought to be on the euro zone muddling through this crisis – this would suggest that any potential flare-ups in the euro zone crisis, (Spain, Italy, Greece or Cyprus) will have the potential to send shockwaves to risk sentiment."

ETX Capital believes we should see a swift move lower after a rally across global markets, and Siddiqi said the potential for a bank run remains intact. That could cause a collapse of the banking sector in Cyprus, he said.

"The situation is still delicate and by no means a sure bet that Cyprus will not need more bailout money in the years ahead. Markets are welcoming the news today but will re-shift their focus back on Italy and the political deadlock which still unnerves investors," he said.

(Read More: Will the Cyprus Deal Take the Euro Far?)

Despite an eventual move downwards, Siddiqi underlines that liquidity from global central banks will support equity prices in the long term.

The Federal Reserve announced in December that it would buy $45 billion in additional Treasurys every month, on top of the $40 billion a month in mortgage-backed securities it has already committed to, taking the total size of its QE (quantitative easing) program to $85 billion a month. The Bank of Japan has also made an open-ended commitment to continue buying assets and the Bank of England has embarked on a series of asset purchases that have so far totaled 375 billion pounds ($600 billion).

"There's a huge amount of liquidity jumping around. The Bank of Japan is about to embark on theirs. So that'll keep markets moving up," Chris Weston, chief market strategist at IG Markets told CNBC.com.

Gittler said that the rally is reliant on profit estimates for the corporates and whether price-to-earnings ratios continue to expand. That in turn is dependent on continued easing by the central banks.

"I see no sign that any of them are in any rush to remove that prop to the markets," he told CNBC.com.

By CNBC.com's Matt Clinch

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