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Stress testing under the spotlight

Wed, May 6 2009, 07:20 GMT
by Andrew Wilkinson

Interactive Brokers LLC  |  View company's profile

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The dollar continues to move inversely to the fortunes of rising equity markets as investors continue to buy into the story that the global economy has passed the turning point. Financial companies were under less pressure on the day the Federal Reserve is expected to brief executives at the nation’s top 19 lenders over the outcome of the three-month long stress testing. The Japanese yen is surprisingly virulent today posting gains against the dollar, euro and Swiss franc while losing out to the British pound. Investors continue to buy into the prospects for resource currencies driving the Canadian dollar to fresh ground as it advances versus the dollar.

Perhaps 10 days or so ago, a comment from a U.S. official led us to believe that none of the 19 banks whose capital position was being assessed would require more capital. However, that number after jumping to a group of five has suddenly become just over half according to other media sources. But the outcome of the testing is becoming less stressful for three reasons.

First, the testing was meant to examine performance under worse conditions than at present, which would accompany further economic deterioration. The recent shift to a focus on growth has pulled the rug from beneath the bearish stance taken against banks. Second, despite the claims of a costly government bailout of these banks, there appears to be a desire to avoid the tainting of further government hand-holding. Finally, a range of solutions for those not managing to clear the hurdle at the first attempt is within the comfort zone of other investors. Banks have six months to either convert existing preferred shares into common shares or convert existing government stakes into common stock. They could sell assets or they could raise private capital.

In dealing with the problematic financial sector in the manner it has the government has managed to buy a vital amount of time during which it has been able to show investors why the banking system is safe. We noted at the time that Mr. Geithner’s plan was short on detail, but the coincidental improvement in the economic data to a less hasty slowdown has shifted the focus from an out of control five-alarm forest fire to a far more manageable kitchen incident.

Various PMI surveys have been released in recent days. We noted yesterday that a Chinese manufacturing PMI indicated expansion over and above the stimulus-inspired gains for state-owned companies. Around the globe other coinciding surveys concur that the pace of collapse in output is slowing, with the Australian manufacturing sector in April being the latest as its measure added four points to a reading of 39.8. A measure of below 50.0 indicates contraction while expansion occurs at higher readings.

The Australian dollar is higher against the U.S. unit at 74.60 this morning on this and other domestic factors. The message from the RBA meeting earlier was that it would maintain a 3% monetary policy stance, indicating that the central bank feels it’s done enough. With building approvals rising and doing so at a faster than expected pace in March to give a second consecutive monthly improvement, the latest evidence corroborates that view.

The Canadian dollar has broken through overhead resistance (futures-wise) and was higher earlier on commodity-related optimism. Currently those gains have been pared back to 85.25 U.S. cents.

Investors can’t get enough of the British pound at present, which is also benefiting from a revival of risk appetite. The pound traded at its highest against the dollar since January and is just coming back from an earlier rally to stand today at $1.5085. The slowing contraction today showed up in a commercial property survey, which showed that ultra-low monetary policy is likely behind the lightest contraction in confidence and activity in office and retail space in a year. The Bank of England meets Thursday and is unlikely to reduce policy from its current 0.5% rate of interest.

Published on  Wed, May 6 2009, 07:25 GMT

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