The Equity markets showed continued strength as positive earnings and solid European economic data continued to drive the US markets. The S&P 500 Index moved up 9 points to reclaim the 1100 level.Europe Faces Stress Test
The European bank stress tests are the major event of the week and lots of headlines came out about the stress test results. Committee of European Banking Supervisors (CEBS) that ran the tests said that of 91 banks tested, seven failed. Every German bank passed except the one real estate entity singled out by rumors this past week, even the Landesbanken all passed. All four French banks that were tested passed. All four Portuguese banks that were tested passed. All five Italian banks passed. Five Spanish cajas failed, while all of its commercial banks passed. One Greek bank failed. Results so far have come in pretty much as leaked. Tier 1 capital estimates for all the banks were released, showing what would happen under alternative scenarios. CEBS said that the 7 banks that failed had an overall Tier 1 capital shortfall of EUR3.5 bln, and that it assumed EUR67.2 bln of losses under the “sovereign shock” scenario. These assumptions are incredibly low and suggest that the stress tests really weren’t that stressful. Calculating the impact of various scenarios haircuts is made even more troublesome if banking books are not included in the exercise. Failure of the stress test does not mean the bank is insolvent, but simply means that its capital cushion falls short of what is considered prudent under the stress scenarios. Market contacts suggest that a number as high as USD100 bln for need to raise capital would be acceptable to the markets. Anything too low and markets will question the stress assumptions, while anything too high and concerns about the banking sector will pick up again. Overall, the transparency on the stress test is solid to the extent that any analyst can go to the ECB’s web site and run their own stress test using their own assumptions on any European bank. This is a major step, and although a trader might not agree with the assumptions made by the banks and regulators, the calculations for the stress test are easily available.
In the UK, better than expected GDP number helped push the pound toward resistance. Britain’s economy grew much more quickly than expected last quarter, underscoring the sturdiness of its recovery and easing fears that the euro zone’s debt problems and ambitious austerity measures at home could push the country back into recession. In its preliminary estimate Friday, Britain’s Office for National Statistics said gross domestic product, a broad measure of the value of goods and services produced by the economy, rose 1.1% in the second quarter from the previous period, and expanded 1.6% between April and June from 2009′s second quarter. Economists had expected growth of roughly half that amount, 0.6%. Britain’s economy expanded 0.3% in the first quarter. Measured on a seasonally adjusted annual rate, as is the custom in the U.S., the U.K.’s GDP grew about 4.5% in the second quarter. The initial GDP report showed Britain’s services sector growing 0.9, the fastest rate in three years. Services account for roughly 75% of Britain’s GDP. Manufacturing also grew healthily, while government spending contributed only 0.2 percentage point to the growth rate last quarter.