Phew…Glad that is over! The European bank stress tests promised to be more invigorating than an episode of The Jersey Shore; it proved to be about as exciting as an insurance convention. So now what?
On Fast Money last Friday, we were met with a healthy dose of skepticism when we asserted that the stress tests provided clarity. Our point then, and now, is that the market now knows the risk lies not in the trading book, but in the held-to-maturity bucket. Most importantly it gives investors a point of reference and increased visibility into the European banks. Prior to the tests, the European banking world was opaque at best – we would not call the tests an open window, but they did provide enough of a view for the markets to begin to sort out the winners and losers.
Now the task of recapitalizing the banks will commence and this is where the true stress test will be conducted. There has been enough analysis conducted prior to the test that the markets had already decided which banks were the strongest – Barclays (BCS) and Santander (STD) were two of the standouts. Now when peripheral banks attempt to tap the market for financing, the rate they must pay will indicate their level of stress.
One result of the test was that it rendered 3 Month Euribor insignificant as an indicator of financial fear. This morning (Monday), 3 month Euribor reset at a higher level than last week – the implication is that there is more stress in the system today than last week. We could not disagree more with the interpretation of a higher Euribor. This metric is an amalgamation of bank rates; now that the market has been left to sort out the winners and loser, an average rate tells us nothing about individual levels of stress.
As the banks head to the markets for funding, we expect the gap between winners and loser to widen. Additionally, we expect the interest rate differential between Europe and the U.S. to remain elevated – this in turn should attract risk capital to the Euro currency. A higher level of interest with increased clarity could be the catalyst for higher Euro prices.
We purchased EURUSD overnight in Asian trading and anticipate adding to the position on strength.
Disclosure: Long EURUSD and FXE