Global Daily – Stress testing the strong

by: Tomas Kinmonth , Nick Kounis , Georgette Boele , Roy Teo

Euro Financials: Bank stress tests to focus mainly on more healthy banks – On 29 July at 22.00 CET, the next round of European bank stress test results will be announced. Unlike in 2014, when 124 banks were evaluated, this time just the top 51 banks in Europe will undergo the assessment from the European Banking Authority (EBA). Neither Portugal, Cyprus nor Greece have any bank within the scope of the 2016 test. Unlike in 2014, the 2016 EU-wide stress test does not contain a pass/fail threshold, likewise no hurdle rates or capital thresholds are defined. However, the adverse scenario is slightly tougher over the three-year period than in the previous test in 2014. We think it is a missed opportunity that the EBA 2016 stress tests will not be used to do a more comprehensive and deeper health check of the banking system in Europe. Indeed, the fact that 72 smaller banks are excluded from the test will significantly reduce the coverage and impact. This is especially the case as in some countries the smaller banks are the least sound. Of the banks that failed in 2014, only Monte dei Paschi di Siena is being tested again. A poor performance in the tests could potentially allow the Italian government to bypass the bail-in rules, and bail-out the bank, though this is far from certain. Overall, we expect the results will have a limited impact on European bank fixed income markets due to the exclusion of almost all of the failed banks from 2014, the lack of a pass/fail result and the lack of immediate requirements for banks to conform. For more on this issue, please see our note here that is intended for professional and eligible clients only – see disclaimers in note. (Tomas Kinmonth)

 

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Central banks: BoE hawk now in favour of immediate stimulus – MPC member Martin Weale signalled that he now favours immediate monetary stimulus in an interview with the Financial Times newspaper. Although only one of nine Committee members, the change in tone is significant, as Mr Weale is one of the most hawkish BoE officials. Indeed, only last week he was making the case for a wait-and-see stance at the August MPC saying ‘uncertainty points to the argument that we should wait for firmer evidence before making any policy change’. However, he has clearly shifted, due to the weak PMI readings, which suggest the UK economy had fallen into recession. Mr Weale admitted that the data were ‘a lot worse than (he) had thought’ and were ‘very material for the decision we’ll be taking next week’. We think that aggressive monetary stimulus remains very likely next month. We expect (a) a 25bp reduction in Bank Rate (b) the launch of an GBP 150bn purchase programme taking total target to 525bn to be carried out between September 2016 and June 2017 – mostly gilts but also including credits with monthly purchases averaging 15bn (c) an easing of borrowing conditions for banks in its Funding for Lending Programme. (Nick Kounis)

Global FX: Not much room for dollar strength – Since 23 June the US dollar has risen. At first, the decision of the UK to leave the EU resulted in safe haven flows. Afterwards investor sentiment improved and better-than-expected US data have supported the US dollar again. Expectations of a Fed rate hike this year and in the coming years have increased somewhat, but they remain low. Overall, investors remain cautious ahead of the FOMC meeting. A dovish tone in the FOMC statement later today will likely weigh on the US dollar and we do not see much room for dollar strength going forward (with the exception of against sterling). The Japanese yen outperformed major currencies so far this week; USD/JPY dropped from above 106.50 to 104. The Nikkei news report that fiscal stimulus is likely to be smaller than previously reported (JPY 6 trillion versus 10-20 trillion) gave a boost to the yen. In addition, a supplementary budget of only around JPY 2 trillion will be passed this year. Later this week, on Friday, the Bank of Japan (BoJ), will decide on monetary policy. Financial markets have mostly priced in our view that the BoJ is likely to lower the policy rate by 20bp to -0.3%. Therefore, the BoJ’s decision will unlikely result in a sharp weakening of the yen (Georgette Boele & Roy Teo).