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Summary

  • Reason why political turmoil may not have big input to the value of the Euro.
  • European Banks have big loan exposure in Russia.
  • There is confusion on the ground in the Ukraine and more confusion at the diplomatic table.

Last week Ukrainian leaders in Kiev decided they needed to take military action to dispel Russian sympathizers who had taken possession of government buildings near the Russian border in the town of Kramatorsh. Six Ukrainian armed personal carriers were dispatched to the border to reclaim buildings occupied by either Russians or their friends.

The plan did not work. The occupants of the tanks were ill prepared for the four-day trip and arrived at Kramatorsh tired, hungry and not prepared to engage in combat with fellow Ukrainians. While front line reports are murky, it now appears these warriors were captured by the locals. Ownership and current operators of the six tanks remain unknown to the embarrassment of the Kiev leaders.

At Donetsk, another border city with Russia, local unarmed civilians have blocked the progress of airborne troops on armed personal carriers Kiev leaders had sent to reclaim that area. The situation on the ground is confusing as are the diplomatic negotiations.

It is obvious the Russians want to expand their borders and influence beyond the current boundaries. For the EU, NATO and the US, their objectives seem muddled. The US wants sanctions but the EU and Russian economies are closely entangled. The Russians are as dependent on energy sales to Europe as the EU members are dependent on natural gas and to a lessor extent crude oil for their energy needs. Threats by the Russians to interfere with the flow of or the price of energy to Western Europe would hurt the EU economy, but yet the Russians need the EU revenue.

So far the energy flow to Europe has not been disrupted. While the market is certainly wary of the risks of trade sanctions with Russia, this has not happened perhaps because of the "too big to fail" concept. Remember Reuters reported Russia owes Western banks $650B. The threat of $650B of non-performing loans is real serious business, bound to keep the diplomats at the bargaining table for quite a while.

There is another reason the EU needs to get along with the Russians. There are bank stress tests scheduled to be completed by the ECB in October. In preparation for these stress tests, it was reported today the 20 largest EU Banks had set aside €71.5B ($98.89B U.S.) in 2013 to boost capital requirements so they would pass these tests. There are a total of 128 banks to be inspected and most are thought to have taken steps to avoid a capital shortfall. In the same story it was reported:

ECB President Mario Draghi himself has highlighted progress already made since they learned of his plans and said this month he was "pretty confident" that the testing regime would "find a stronger banking system than we had before announcing it.

Besides the $650B of outstanding debt there is another reason EU Bankers are loathe to make any Russian demands in response to their military adventures into the Ukraine. They are fearful it would be far too pricey.

Currently the interest rate paid on sovereign debt is quite low. In Spain the 10-year rate on sovereign debt is only 3.06%, while in Italy the rate is 3.10%. On this date last year the rate of the 10-year sovereign paper was 4.73% in Spain and 4.35% in Italy. EU banks, loaded with sovereign debt, have a big "mark to market" profit on their loan portfolio as the rates have worked lower. This portfolio profit should provide a cushion for the stress tests this fall unless the rates work higher.

This does mean the political driver for the action in the euro is totally removed. It does seem, however, the economic risks for the EU, their energy costs, their outstanding bank debt and risk of mark to market losses should rates work higher would all make entering a civil war in the Ukraine far too costly.

If this is true the EURUSD (FXE, UUP, UDN) may be stuck in a trading range subject to pending economic numbers. Currently the bottom of the range looks to be in the 1.3650 area and the top around 1.39 handle. We would expect Draghi to grumble about the high euro value as the top of the range is approached. For the EU and the prosperity of their banks and their economic health is far more important than some disputed land in the Ukraine.

We need then to thoroughly watch the US economic inputs to see if this will give us reasons for the pair to break from the current range.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: When Does The Euro Break Out Of Its Range?