The result of Friday’s banking sector stress tests turned out to be as equally uninspiring as the market had feared.
In fairness, the European Banking Authority was on a hiding to nothing however the results turned out. If they were too few failures then they would be accused of not being robust enough, and if they painted a doomsday scenario then they could well sew further contagion and uncertainty that we are getting a flavour of this morning.
Of the 91 banks tested, eight failed outright with an additional sixteen needing to raise additional capital to get their tier 1 ratio up above 6%.
No Irish banks failed, somewhat surprisingly given the number of variable rate mortgages in the country. That and the fact that the ECB appears to be on a destructive rate tightening cycle, which will put increasing pressure on borrowers in the coming months.
The job of the EBA is not being helped by EU policymakers and their continued failure to get to grips with the problems. Instead of focussing on trying for a resolution to the problem they are focussing on lashing out at the ratings agencies for pointing out what everyone else already knows.
Furthermore it is reported that G20 global regulators are expected to endorse measures that they hope will protect taxpayers from having to rescue failed banks, by the implementation of a capital surcharge on bank balance sheets. While this appears to be a noble goal it rather misses the point if taxpayers have to then bail out indebted sovereigns.
This is what Germany is worried about with respect to the euro bond proposal which on the face of it would seem to be the obvious option to stave off an imminent crisis.
The head of the German Bundesbank Jens Weidmann came out steadfastly opposed to such a measure at the weekend, putting him on a collision course with countries like Greece and Ireland who are in favour of such on option.
It is not hard to see why Germany is opposed to this measure given that it could well see their borrowing costs rise and even possibly affect their triple “A” credit rating, given that they would ultimately be standing surety for the debts of peripheral Europe.
The ECB on the other hand remains vehemently opposed to any type of debt restructuring with Trichet reiterating at the weekend that any country that defaulted would find that there bonds would no longer be accepted as collateral by the bank.
At the same time the bank remains intent on bearing down on inflation in Europe at the expense of mortgage holders in Spain, Ireland and Portugal where there are a larger proportion of variable rate mortgages that are extremely sensitive to interest rate movements.
Increased borrowing costs over the next 12 months are likely to depress asset values further and increase the pressure on banks’ balance sheets as more and more mortgage holders come under pressure, crystallising more bad debts.
In Italy 10 year bond yields continue to rise back towards last week’s 6% highs despite the passing of an austerity budget last week, signalling a loss of faith in the Berlusconi government.
As a result on the forex markets is that the single currency continues to remain under pressure despite continued entreaties from policymakers that the euro remains a strong viable currency.
Key support for EUR/USD remains around the 200 day MA at $1.3915, which is also the 50% retracement of the up move from $1.2870 to the $1.4940 highs.
The 100 day MA at $1.4290 continues to act as a cap for any rallies.
Forex Trading - China Buying the Euro?
Talk that China remains a buyer of euro at lower levels for now appears to be limiting downside in the single currency, especially against the US dollar, but with gold and Swiss franc surging to record highs, that is more of an indictment of the US’s own problems than any perceived confidence in the euro.
This week’s meeting of EU leaders continues to take on a greater importance with respect to the current crisis, however in focussing on a new Greece bailout and talking about setting up a new European ratings agency, politicians would appear to be focusing on the wrong issue at a time when Italian and Spanish bond yields are pushing up near and above 6% towards the key 7% level that precipitated bailouts for Greece, Ireland and Portugal.
It is becoming increasingly apparent that some form of debt restructuring will have to happen and the ECB will have to back track on its opposition to such a measure given that the current debt burdens remain completely unsustainable.
In the meantime while the current policy paralysis continues, investors are now becoming concerned that politicians have no concerted plan to deal with a problem that could be starting to run out of control and spread to Spain and Italy, which could well then spell the demise of the euro as we currently know it.
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Original article written by CMC Markets as of 18 July 2011.
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'Forex Trading: European Stress Tests and the Euro Remains Under Pressure' edited by DB, updated 18-Jul-11
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