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By Shavasb Bohdjalian
Forex traders showed their disappointment with the results of the eurozone bank stress tests by knocking the euro lower in early week trading. Eight out of the 90 banks that failed the July 15 tests had only a combined capital shortfall of 2.5 billion euros, the European Banking Authority said on July 15.
The market was disappointed because regulators didn’t include a Greek default in the tests even though credit default swaps indicate investors see an almost 90 percent chance of one. The EBA included a 25 percent writedown on 10-year Greek bonds held in banks’ trading books even as the securities trade at about 51 cents on the euro.
What the market wanted to know is the effect on eurozone banks of a possible Greek sovereign default and how much capital the banks would need in such a scenario. With the market increasing discounting such an outcome, a number of analysts believe European banks may have to raise as much as 80 billion euros of additional capital if a default becomes a reality.
A number of analysts however said that enough information has been released to allow them to analyze the bank results and do their own stress tests, thus gaining an unfair advantage over the rest of the market participants.
The next important item on this week’s agenda is the EU Heads of Summit on July 12 and as an analyst at Soc Gen said, maybe by then the 'French plan' and 'German plan' will have turned into a proper plan preferably supported by the ECB and politicians, combined with some intervention in the secondary market to support peripheral bonds. Between now and then however, there's not much upside for the euro.
Meanwhile things are not very rosy across the Atlantic as Republican and Democratic senators sought on Sunday to craft a plan that could avert a government debt default should the talks remain stalemated. Even if they do come up with a plan, though, Standard & Poor's had said last week that it may still cut its Aaa rating on U.S. debt if the agency is not convinced of medium-term stability in the fiscal situation.
Failure to increase the debt ceiling by then could send shockwaves through global financial markets and may plunge the United States into another recession, economists have warned.
Republicans want a deficit-cutting deal before they will vote to raise the debt limit but they do not like Democratic proposals to raise taxes on wealthier Americans. A number of analysts however do not share the view that failure to pass a deal will send borrowing costs higher. Instead, they argue that even if the US loses its triple A rating, investors will continue to buy Treasuries, thus forcing rates lower. They cite the case of Japan which has seen rates move lower and lower, despite the country having the highest debt in proportion to its GDP among the industrialized nations.
With talk of default on both sides of the Atlantic, gold continues to shine, hitting one record high after another, but the rally close to $1600 per ounce looks overstretched once people realize that the eurozone will remain intact irrespective of this week’s EU Summit or even if Greece defaults and the US of A will continue to be a superpower for a long time to come even if it loses its high rating, which should have been reduced a long time ago because of the deterioration in state finances and rising debt. Once this reality sinks in and people get used to the idea that things will hum along despite the woes, then profit taking will set in and we shall probably see gold retreating back towards the 1400 area and the euro staying in its range against the dollar.
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(Shavasb Bohdjalian is an approved Investment Advisor and CEO of Eurivex Ltd., a Cyprus Investment Firm, authorized and regulated by CySEC, license #114/10. The views expressed above are personal and do not bind the company and are subject to change without notice. Investing in markets and trading on leverage is highly risky and it may not be suitable to all investors since it carries a high degree of risk and you can lose more than your initial investment)
