Global Investing

EU stress tests: who knows, who cares?

The following is a guest post by Christopher Whalen, senior vice president and managing director of Institutional Risk Analytics. You can also follow him on twitter. The opinions expressed are his own.

Waiting for the results of the EU stress tests, one is reminded of the many times in the past century when the U.S. has rescued the Europeans from their tendency to wage war against one another and go broke in the process. Having now helped to sell the EU banks much of the subprime garbage that sank the likes of Bear Stearns and Lehman Brothers, now the U.S. is offering a solution, namely to mimic the U.S. stress tests of 2009.

The U.S. stress tests, keep in mind, were about restoring confidence, not measuring financial soundness. The assumptions in the U.S. stress tests were soft and virtually all of the banks passed. The U.S. government had already guaranteed the liabilities of most U.S. banks, General Electric and General Motors, and a variety of other formerly non-bank companies. Thus the stress tests are properly seen as an exercise in managing expectations of the bond vigilantes.

The U.S. process was reasonably credible to investors because, despite their many failings, American regulators have a cohesive, if fragmented, approach to gathering data from regulated banks and disclosing same to investors. The data used in the stress tests actually bore some resemblance to public data available on these institutions.

In the EU, on the other hand, there is virtually no transparency on bank financial statements and thus no visibility for investors in terms of making the stress tests credible. There is no SEC in Europe, no EDGAR or FDIC portals on the internet with extensive financial data on banks. There is not even a common template for gathering financial data on European banks or even credit statistics for many EU consumers.

The Big Five: themes for the week ahead

Five things to think about this week:
    
PUTTING THE RALLY TO THE TEST
- The surge in risk markets has tapered off as investors take stock of recent weeks’ rally and the data flow injects a dose of sobriety. The scale and duration of any market pullback will be the test of how much sentiment has really changed. Sluggish April U.S. retail sales were the biggest cause for pause and this week’s flash PMIs will give more Q2 information.

FX FOCUS
- A pause in the recent recovery in relatively risky markets is shifting attention to the changing FX environment. Clear-cut correlations between moves in major FX rates and swings in risk appetite could be in the process of being eroded and some in the financial markets are wondering if and when relative economic performance will replace risk appetite as a driver for exchange rates. Investment flows will be affected if the dollar looks like it might resume a long-term downtrend.

QE EXIT STRATEGY
ECB, BOE, Fed officials are making reassuring noises about QE exit strategies but no clear mechanism or timeframe has yet emerged and all indications are that balance sheet expansion is still the order of the day. Yield moves suggest bond markets are more enthused in the short term by signs they will kept on the QE drip feed than by concern about the potential price problems down the road. Central bankers have yet to address the back up in yields that would be seen if they were they to exit the market at a time when debt issuance is continuing to flood the market – as it will for some time to come.

Big Five

Five things to think about this week:

REBOUND
- The global stock market has lost some of its spring, although it still managed a seventh straight  week of gains last week. A serious pullback has yet to be seen and the VIX is managing to hold fairly close to the sub-40 lows. Faced with a deluge of earnings, investors are picking their way through a mass of mixed earnings news and forecasts and displaying a more symmetric reaction to good/bad news than in past months.

STRESSES
- The U.S. financial stress testing timeline will put the focus back on the health of financials. Results, which are expected to point out banks’ varying ability to cope with a severe recession, are due out on May 4 and the financial industry is already flagging the risks of failing to spell out what would happen to the weaker links in the chain. Stress test results and any rumours or leaks before publication could prompt volatility.

DATA FLOW
- The release of advance Q1 U.S. GDP will offer investors a clearer sense of whether worst is in the past and could point way to what might feed any eventual “green shoots” of recovery. In the euro zone, national and regional sentiment indicators will point the way to firms’ and consumers’ mood at the start of Q2.