• Euro Seems to Take the Stress Test Results Well but the Details Leave Much to be Desired
• British Pound Surges (Within Risk-Defined Bounds) on Strong GDP Results
• Canadian Dollar Absorbs Disappointing Inflation, Retail Sales Data to Refer to Later
• New Zealand Dollar will Look to Supplement Risk Appetite Volatility with an RBNZ Rate Decision
• Swiss Franc Follows the Euro but Individual Stress Tests Paint a Better Picture
Dollar May be Set for Gains if the Reality of the EU Stress Test, China’s Loan Troubles Set in Monday
The dollar – like most other risk-sensitive assets – would struggle for direction Friday. In fact, the benchmark currency would end both the session and week little changed from where it had started. Many will take the lack of response from the dollar and the market in general to the major event risk today and interpret it to mean that a prominent fundamental wave has passed and left the markets relatively unscathed. Such a conclusion may be jumping the gun however. The surprising lack of reaction to the European Union’s Stress Test results is perhaps not so surprising when you consider that the report was not released until after the European markets were closed and liquidity was significantly drained. With only a few active hours for the Western hemisphere to interpret and react to the convoluted and dubious report, it seemed the safe route was to hold back from major shifts in portfolios or risk assessments and reflecting on the details over the weekend. This was almost certainly officials’ intention when they decided on the timing. However, there is no guarantee that a period of contemplation will actually improve the conclusion market participants reach. The gaps in logic and reason behind this evaluation of a strained financial system are quickly exposed. Chief among the issues that skeptics will attack are concerns that the scenarios that were used were too lenient; the assessment for each region and bank was unique and was therefore too subjective; and the basic fact that it is the smaller firms that are actually at risk of failure (a stress in the entire system can easily amplify the threat).
Come Monday, liquidity will fill out and the masses will make their collective judgment of the value in this stress test. Even if doubt is the ultimate opinion, it may not necessarily alter the bearing on the markets. Another shock to the system can offer a tangible impact. One burgeoning threat to the Euro-area that arose today was credit rating agency Standard & Poor’s warning that Hungary could see its credit rating downgraded in the near future owing to its deficient budget effort and the loss of a credit line from the EU and IMF. The European financial system is particularly exposed; but the spread of a global crisis or even the spark for one could be the responsibility of a completely different region. With the headlines dominated by US earnings (which have lost considerable sway over risk appetite recently) and European troubles, the troubles in China are continuously downplayed. Today, Bloomberg News quoted a Chinese official who said banks that made 7.7 trillion yuan ($1.1 trillion) in loans to regional government vehicles used to fund building projects may not recoup nearly 23 percent of the initial outlay. In fact, given the modest return from the projects so far, only 27 percent of the loans could be covered as of today.
The bearing of risk appetite is the first concern for the US dollar into next week because the potential to spark demand for return or safe haven (like the greenback) is so high. Yet, deeper currents could alter the dollar’s path going forward. A growing burden for the currency over the past few weeks is the diminished outlook for growth – a dynamic that is important for the transition from safe haven to yield-bearer when the global mood shifts. The advance 2Q GDP reading for the US on Friday will lay to rest speculation over the pace of the world’s largest economy.
Related: Discuss the Dollar in the DailyFX Forum, Dollar Losses on Growth Concerns Restrained by Euro Uncertainty
Euro Seems to Take the Stress Test Results Well but the Details Leave Much to be Desired
At first blush, it would seem that there are a few holes to fix in the European financial system; but otherwise, the region is in good shape. However, this is as simple a scenario as merely accepting ECB officials and policy makers’ assurances that the everything is fine in the Union’s finances. There should be at least some skepticism as these parties are charged with inspiring confidence. When we cast a critical eye over the results of the Committee of European Banking Supervisors’ evaluation of the group’s 91 largest banks (accounting for 65 percent of total assets), we see that the seven firms that fall short are already in some way supported by the government. Therefore, they pose little threat. The next concern is over the methodology of the tests themselves. The scenarios don’t account for a sovereign default or a particularly significant regional crisis. Furthermore the accounting for losses on sovereign debt can be pushed off depending on how the banks report. This test leaves much to be desired; and suggestions from the ECB’s Nowotny that these terms were more severe than the US stress test are borderline absurd.
British Pound Surges (Within Risk-Defined Bounds) on Strong GDP Results
It is unfortunate that the EU event risk had encouraged lethargy across the market; because the top event risk for the British pound would prove fundamentally interesting. Completing the picture of interest rate speculation, fiscal health and growth; the advanced reading of 2Q GDP bested expectations and pointed to a surprisingly robust recovery. The 1.1 percent expansion through the three months matched the strongest pace in nine years. It is unlikely this upswing will further accelerate going forward; but this boost puts the UK closer to par with its peers.
Canadian Dollar Absorbs Disappointing Inflation, Retail Sales Data to Refer to Later
The Canadian dollar’s evolving correlation to yield speculation and risk trends has distracted the market from underlying developments that can in fact define the currency’s connection to speculative trends. Yesterday, the drop in retail sales through May lowered growth expectations. Today, the burden has been placed upon the outlook for interest rates as the core pace of CPI unexpectedly cooled to 1.7 percent pace.
New Zealand Dollar will Look to Supplement Risk Appetite Volatility with an RBNZ Rate Decision
Where goes equities, so does the kiwi dollar. That has been the trend over the past week; and it will likely describe 80 percent of the currency’s performance over the coming week. However, the other 20 percent in that equation could prove a ‘fat tail’ for volatility. An RBNZ rate decision is expected to end with a quarter-point hike to 3.00 percent. This is already priced in. What really matters is expectations for the future.
Swiss Franc Follows the Euro but Individual Stress Tests Paint a Better Picture
Perhaps looking to caste an image of responsibility, the Swiss attempted to boost confidence by releasing stress test results for their own largest banks. The test was supposedly more rigid, the results better and more believable. However, the franc’s existence going forward is still as the counterpart to the ever-volatile euro. Should fear overtake the EU once again, it will mean another rally for the Swiss currency.
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Written by: John Kicklighter, Currency Strategist for DailyFX.com
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