Remember Euro Breakup Fears? They Are Back
After months of calm in global markets, concerns about the future of the euro zone are back with a vengeance as fears grow that the turmoil in Cyprus could spread to other parts of the region and ultimately undo the single-currency block.
Those jitters saw investors dump government bonds in peripheral euro zone countries on Wednesday and push the euro to a four-month low of $1.2750. The currency was trading not too far from those levels in early Asia trade on Thursday.
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Banks in Cyprus are scheduled to reopen on Thursday and are being watched closely for a sharp withdrawal of cash by depositors that could spread to other euro zone countries.
"If you're not worried about Cyprus, then you're not thinking clearly because the contagion that people are talking about is a bank run elsewhere in the euro zone," Mike Crofton, president and CEO at the Philadelphia Trust Company told CNBC Asia's "Squawk Box."
"It will be interesting to see if there's a run on the banks in Cyprus and if there's contagion, I am fearful that the euro will collapse," he said.
On Monday, international lenders agreed to a 10 billion euro ($12.7 billion) bailout for Cyprus. In return for the funds, the tiny European island will shut one of its main banks and downsize another, with heavy losses for large depositors.
Cypriot banks will reopen under tight controls to prevent depositors fleeing. According to Nomura analyst Jens Nordvig, the capital controls in themselves suggest the euro zone may already have splintered apart.
"The type and breath of capital controls imply that there are now clear elements of currency separation in place. A key parameter going forward will be how long these controls remain in effect," Nordvig said in a note.
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"If only very temporarily, it may not be a big deal. If more permanently, the effect will be pronounced. Since, we don't know for sure, we are arguably in a grey zone regarding whether the euro has broken," he said.
According to Peter Morici, professor at the University of Maryland, "the fallacy of the euro zone is coming forward."
"If the euro zone is so good for people's economies, why are Italy, Spain, Portugal, Greece and Cyprus facing years of 20 percent unemployment? Over time we are going to have more Cypruses, more bank failures," he said on "Squawk Box" Asia.
Bond Market Jitters
In a sign that worries about the fallout from Cyprus are growing, Italy struggled to sell 6.9 billion euros of five-year bonds at an auction on Wednesday, while yields on Spanish debt crept above 5 percent, a worrying sign for analysts.
"The real concern is if we see deposit flights from countries other than Cyprus, which is why we've seen bond-yield spreads on Spain, Italy, Portugal blow out and that has contributed to weakness in the euro," said Ray Attrill, co-head of foreign exchange strategy at National Australia Bank in Sydney.
A lack of progress in forming a government in Italy following inconclusive elections last month create a further headwind for the euro, which could head towards $1.2450 if fresh elections are called, Attrill said.
Comments earlier this week from the head of the Eurogroup Jeroen Dijsselbloem that theCyprus bailout could provide a template for future agreements have weighed on sentiment even though those comments were later modified.
"Right now it's more volatility than crisis. You can see how Cyprus can unravel but it always seemed too small to actually head in that direction," said Andrew Pease, global head of investment strategy at Russell Investments in Sydney.
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"Really, Italy and Spain are where the real challenges lie and you can't help but feel that we are heading towards at least a mini-escalation of European fears over the next few months and that's certainly going to be a headwind on what has been a pretty impressive share rally so far in global markets," he added.
- By CNBC.Com's Dhara Ranasinghe; Follow her on Twitter :@DharaCNBC