Opening Comment 07.26
The general consensus and feedback in the two weeks leading up to the stress test results was quite positive, so it wasn’t much of a surprise to see the results come out on the upbeat side.
However, the major concern heading into the tests and now after the tests is that the tests were way too lax and have helped very little, if at all, to instill a higher degree of confidence in the European banking system. The tier 1 capital ratio requirement of 6% seems to be quite low, and this compares to a Swiss tier 1 capital ratio of 8% in their latest banking tests. It is quite clear from the results that there were a good number of banks that would have failed the European stress tests had the tier 1 ratio been just a little higher, andthis clearly casts a major shadow of doubt on the effectiveness and validity of these tests.
Many investors will argue that when the US stress tests were released last year, they were also somewhat lax and suspect, and yet the markets managed to recover quite impressively still. As such, even some form of clarity in the European banking system should help to bolster investor appetite. We are not as convinced of this logic, as the positive market reaction following the US stress tests could just as easily have been attributed to policy assurances from authorities in the US that no bank would fail.
In our opinion, the Euro should be exposed to some weakness, at least over the next few days, with all of the positives having already been priced in and plenty of question marks surrounding the drive behind the latest surge in the single currency. Over the medium-term, as the stress tests fade out of the headlines, it will become much more difficult to determine longer-term direction. The US is also clearly riddled with some deep structural issues that have crept back in over the past several weeks, and given that the yield differential between the Euro and USD is more or less a wash, the currency which benefits the most will be the currency which can show the greater likelihood for a quicker sustained recovery.
Looking ahead there is no data scheduled for release in the European session, and this should be a welcome development with the markets having plenty to deal with in terms of deciding on the proper way to react to the latest stress test results.
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