Nervous Calm in Forex Markets to Start the Week

The US dollar is little changed to start the week. The apparent calm masks heightened geopolitical tensions in Ukraine and Gaza. Equity markets are trading heavy and this is helping to give the core bond markets, including US Treasuries, a better bid tone.

Investors are digesting the weekend developments and awaiting this week’s key data. US and Japanese CPI figures, euro zone flash PMI, and UK retail sales and first estimate of Q2 GDP are the main highlights.

Of note, the Bundesbank warned in its monthly report that the euro area’s largest economy stalled in Q2. It accounts for about 30% of the EMU economy. The official release is not for a three more weeks (August 14). Recall that industrial production and construction fell in both April and May.

This casts a pall over the region. French industrial output also fell in April and May. Italy, the third largest economy in the region, reported a sharp fall in May industrial output (largest decline in since late 2012), and earlier today, reported a 1.1% decline in industrial orders. The slowdown in Germany appears to have taken a toll, as foreign orders fell 4.5%. Domestic orders slipped 0.2%.

Chinese officials have been busy. China and Switzerland reached an agreement on a CNY150 bln/CHF21 bln (~$23.5 bln) three-year swap line. SNB officials indicated the agreement will also allow it to invest some (without specifying how much) of its reserves into Chinese bonds.

Many observers have argued that the increased international role of the yuan reduces the role of the dollar, but this is another example of why the situation is more complicated. Nearly half of the SNB’s reserves are in euros and a little more than a quarter are in dollars. It seems likely that the SNB diversifies out of the euro more so than the US dollar.

China also struck a new agreement with Argentina. A CNY70 bln swap agreement (~$11 bln) was announced. China will also help finance infrastructure projects in a deal that could be worth nearly $7 bln. While the infrastructure assistance and swap line may be helpful, it doesn’t really solve Argentina’s most pressing problems, including the lingering problem with the holdouts from the previous debt restructuring.

Chinese swap lines have captured the imagination of many observers, but they have not been used. Nor will the swap line help Argentina to bolster its reserves, which have fallen to around $30 bln. It is not yet clear, the real function of the swap lines in a world in which most trade and finance does not use the yuan and the yuan’s convertability remains limited.

Lastly, Russia’s markets are under pressure. The stock market is off about 1.4% to extend last week’s losses. The 10-year benchmark bond yield is up 9 bp to almost 9.0%. The ruble itself is little changed. The EU foreign ministers meet tomorrow and barring some new initiative from Russia appear poised to extend its sanctions. The UK and the Baltics are pressing their case, while even some of the more reluctant EU members, like Italy, appear to be hardening their rhetoric . The tragic shooting down of the commercial plane and the response by Russia appears to be a turning point in the six month crisis.