Cyprus rallies after election

Cyprus' spreads rallied significantly in a day becalmed by the school half-term in the UK and the Presidents' Day holiday in the US.

The Mediterranean island saw its spreads tighten by 81bps to 889bps after the conservative leader Nicos Anastasiades emerged as the clear leader in the first round of the presidential elections. Anastasiades is now expected to secure victory in the run-off against the communist-backed independent candidate next week.

The weekend election had unusual significance - for the wider eurozone, as well as Cyprus itself. Anastasiades is in favour of the EU bailout requested last year, and the austerity policies that will inevitably come attached. His probable election is therefore a positive development for the sovereign's credit standing.

However, it is the structure of the bailout, if and when it is agreed, that will have an impact beyond Cyprus' borders. The banking system, which is very large in proportion to the country's GDP, has been severely damaged by its exposure to Greece. The recapitalisation needs are immense for an economy of Cyprus' size, and the added bailout debt could push the country's debt burden to unsustainable levels.

Depositors and senior bank bondholders have so far been protected in other bailouts. But the idea of extending burden sharing to these creditors has been mooted, which could have possible contagion effects across the eurozone's debt market for banks. It is precisely this reason that makes burden sharing by senior bank bondholders unlikely.

However, a large chunk of depositors in Cypriot banks are Russian, and Cyprus may have to accept further aid from Russia as part of the bailout deal. The negotiations will continue over the next few weeks, and spreads could be susceptible to volatility over this period.

The broader market was fairly quiet, with the Markit iTraxx Europe widening by 0.5bp to 113bps in thin volumes.

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