MacroScope

Stress, stress, stress

The European Central Bank will announce the methodology which will underpin the stress tests of about 130 big European banks next year.

It is caught between the devil and the deep blue sea. Come up with a clean bill of health as previous discredited stress tests did and they will have no credibility. So it is likely to come down on the side of rigour but if in so doing it unearths serious financial gaps, fears about the euro zone would be rekindled and there is as yet no agreement on providing a common backstop for the financial sector.

France, Spain and Italy want a joint commitment by all 17 euro zone countries to stand by weak banks regardless of where they are. Germany, which fears it would end up picking up most of the bill, is worried about the euro zone’s rescue fund, the European Stability Mechanism, helping banks directly without making their home governments responsible for repaying the aid.

The pecking order is clear – a bank’s shareholders, creditors and large depositors would get hit first with national governments picking up the slack thereafter. But if it stops there, the “doom loop” of weak sovereigns propping up stricken banking sectors and each dragging the other down will be unbroken.

Moreover, ECB chief Mario Draghi has intervened to say bondholders shouldn’t be hit in all circumstances, for fear of investor flight.

Of euro budgets and banks

Euro zone finance ministers meet today and will have one eye on budgetary matters given a Tuesday deadline for member states to send their draft budgets to the European Commission for inspection, and with protracted German coalition talks keeping other meaningful euro zone reform measures on hold.

Most draft budgets are in but we’re still waiting on Italy and Ireland. Dublin will unveil its programme on deadline day. Italy’s situation is more fluid so we may get something today.

Over the weekend, Dublin said it may quit its bailout by the year-end without any backstop in the form of a precautionary credit line. That would rule it out for ECB bond-buying support, which it probably also doesn’t need. But it needs at least the 1.8 percent growth forecast for next year to keep bearing down on debt.

from Global Investing:

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.

from Global Investing:

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.