Euro Sinks Under 1.35 Support - What Next?

 |  Includes: ERO
by: Ralph Shell


Despite currency specs heavily committed to the short side of the euro, the trade is going their way.

Pressure for additional economic sanctions on EU trade with Russia because of their involvement in the Ukraine may cripple their weak economic recovery.

Who holds the estimated $600B of external Russian corporate debt? What is the future for the joint venture energy projects?

After flirting with the lower side of the 1.35 handle, numerous times, the bears finally emerged victorious. The timing of this down side break is surprising for several reasons. First, it is rare to see the majority of the traders prove to be right. The latest COT futures report showed specs to be short a recent record 106,200 contracts of euro futures and delta related options. Usually a market this concentrated on one side, gets at least one scare, but so far not this time. It is always possible this break is a head fake. Then the EURUSD rallies to the top side of 1.35, and a short squeeze follows.

Another reason for the surprising weakness in this week's sell off was it was not driven by the release of any significant data. Finally, the sell off might be attributed to the EU leaders agreeing to new Russian sanctions, the consequence of Russian involvement with the downing of the Malaysian passenger jet. But despite the gruesome scenes of the recovery of bodies, mostly European, from the Ukrainian fields, the European leaders have yet to respond to the atrocity.

After Russia annexed Crimea, European leaders were urged by the US to impose meaningful economic sanctions on Russia. The European response was timid, conflicted for several reasons. First, they are dependent on the Russians for close to half of their natural gas needs and 30% of their oil imports, Disruption of these supplies could make Europe's high utility costs go even higher. Then, there are the Russian corporate loans. It is estimated the external corporate Russian debt is about $700B. US Banks have $24B, and most of the balance is with European Banks and corporations.

Russia also imports about $350B of consumer goods. Half comes from the EU. Germany and the Netherlands are the biggest traders with Russia. According to the Telegraph, the total bilateral trade between Germany is £60B, and between the Netherlands and Russia, £51B. German exports to Russia include autos, machinery and pharmaceuticals. For the Germans, trade takes precedent over geopolitical issues.

Recent German comments summarized their concerns.

Taking a decisive stand against Moscow while protecting economic interests - that's the challenge facing European governments after the MH17 plane was shot down. The US, for some time, has been calling upon the EU to undertake more drastic measures toward the Kremlin. However, interest groups representing various industries are warning of unforeseeable effects should tighter sanctions be implemented.

"Every third job in Germany depends on exports. If we interrupt German-Russian trade, then we have 300,000 jobs that are affected by this trade," says Volker Treier, deputy head of the Association of German Chambers of Commerce and Industry (DIHK). "There are many companies that have made enormous investments in Russia. Do they now have to pay for a political conflict? As a spokesman for industry, I have my doubts, and we have to articulate these doubts."

There are also numerous connections between the Dutch and the Russians, Dutch exports include machinery, agricultural products, and large quantities of fresh flowers, but the ties are deeper than just trade. The Netherlands offers Russian businesses a tax haven status, and numerous Russian companies are partially domiciled there. The Dutch Russian connection continues. Royal Dutch Shell has joint ventures with both Russian oil and gas exploration activities, and the Dutch also have joint ventures to produce their beer in Russia.

Despite these business connections, Dutch PM Rutte said the EU would approve additional sanctions against Russia should their involvement be proven. To get additional EU sanctions, which would hurt their already wobbly economy, the reluctant German Chancellor Merkel will need to get aboard.

There is a story that started in the WSJ with an interpretation from Zerohedge, which explains why Chancellor Merkel might agree.

(the) NY Fed tapped Angela Merkel on the shoulder with a polite reminder to vote "Yes" on the next, "Level-3" round of Russia sanctions when it revealed, via the WSJ, that "Deutsche Bank's giant U.S. operations suffer from a litany of serious problems, including shoddy financial reporting, inadequate auditing and oversight and weak technology systems."

What could possibly go wrong? Well... this. Recall that as we have shown for two years in a row, Deutsche has a total derivative exposure that amounts to €55 trillion or just about $75 trillion. That's a trillion with a T, and is about 100 times greater than the €522 billion in deposits the bank has. It is also 5x greater than the GDP of Europe and more or less the same as the GDP of... the world.

It looks like the US Treasury Dept is playing some "Chicago politics" with Chancellor Merkel. The Germans have a choice of some level 3 sanctions against Russia, or lengthy questions about the business practices and capitalization of Germany's largest bank. Either way it seems the largest EU economy will be harmed. Perhaps this is why the EURUSD tumbled through the 1.35 support, and shows no sign of recovery. A gradual slide to the 1.32 handle now seems possible.

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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.