ECB Banks stress test, and FED meeting: Central Banks again in the spotlight

Upcoming Sunday, October 26th, the ECB will unveil the results of the health test it has performed on around 130 EZ banks. During the last few days, speculation that some banks, particularly from Italy, Portugal and Germany had failed the test, drove the common currency lower across the board. In between 11 and 18 banks were rumored to have failed the test, yet many experts refer to possible minor “technical failures” rather than risk of defaulting. Furthermore, with current ECB policy, the banks had plenty resources and time, up to six months to recapitalize if needed, so risk seems to be under control. 

Regardless the EUR suffered with the news on Wednesday, Friday brought more speculation about the upcoming result, with a draft of the test pointing at 25 banks showing  a capital shortfall. A bit above expected and not yet confirmed, the headline produced the opposite effect and EUR moved higher along with the rest of high yielders.

Anyway, market reaction will depend of the final ready of how many, and from where those failed banks are: is not the same the main German one that a small bank in Cyprus. If market deducts the EZ  has  healthy financial conditions after the release, that should support a more sustained recovery in bank lending over time, and prove the EZ financial system is safe, which should benefit the currency in term, and probably trigger some short term recovery in the EUR, nothing however  too big.

EUR possible weakness will be more related to the ongoing situation in Europe, rather than the result of the stress test: data during these last days has continued to be weak among the weakest economies, such as Italy or France, while EZ and German numbers have been barely enough to sustain the economy. Over the upcoming days, inflation readings of both will be released, and will likely have more effect on the EUR: already at historical low, if inflation shrinks further deflationary concerns will likely force Draghi to act on upcoming November meeting, dragging the currency lower against most of its rivals.

But the main event of the week will be no doubts FED monthly economic policy meeting next Wednesday, when the US Central Bank is expected to trim the last $15B of its facilities programs. The market will be eager then to know what’s next, and when that will happen. I seriously doubt Mrs. Yellen will come with a certain date for the next logical step: a rate hike. The thing is that with inflation subdue, and the general slowdown among the major economies, it won’t be easy for the Central Bank to return to normal. Even more, some of FED members had been suggesting the FED may not tapper those last $15B next week: FED’s officers are concerned that if inflation weakens further, they might need even to revive QE; and while odds of such happening are limited and against their latest forecast, the scenario should not be disregarded. Highly unlikely, such action should trigger a run in US indexes, but a strong slide in greenback alongside. Tapper with no clear date for a rate high will have a minimum impact in the forex board, while a certain date or a hawkish tone in the statement, also hardly possible, should boost the dollar and triggering selloffs among indexes. 

Once the dust settles and on Thursday, the US will release the preliminary reading of its 3rd quarter GDP, expected to print a 3.0% growth. Albeit correlated with previous first line readings, and depending on where price stands, dollar will likely find support if the readings overcome expectations, but sunk if they miss them, on the back of speculation a rate hike will be delayed further.