Fed Chairman Bernanke has inadvertently fuelled an increase in risk aversion in the wake of his testimony to the Senate. Although Bernanke noted that he did not see the prospects of a double-dip as a high probability event he stated that the economic outlook is “unusually uncertain”. Nonetheless, although such measures would be implemented if the situation deteriorated further, the Fed was not planning on extending its non-traditional policy options in the near term.
USD benefits as Bernanke does not indicate more quantitative easing.
A combination of caution about growth prospects and disappointment that Bernanke stopped short of indicating that the Fed would embark on further non-conventional policy measures left equities weaker, but the USD was stronger, both due to higher risk aversion as well as less risk of the Fed turning the USD printing press back on again. Bernanke is back at Congress today, with a speech to the House Panel. Although this is effectively a repeat of yesterday’s testimony, the Q&A session may throw up additional clues to Fed thinking and potential for extending quantitative easing but I suspect the USD will retain its firmer tone.
In Europe, most attention remains on the upcoming release of EU bank stress test results. Leaks suggest most banks will likely pass the EU bank stress tests, with the notable exceptions of a few Spanish Cajas and German Landesbanks. Already governments in Germany, France, Greece and Belgium have said their banks are likely to pass. We should all be bracing ourselves for relief to flow through European financial markets, but somehow this does not feel like an environment that will welcome such a result. More likely questions will be asked about why did so few banks fail and why the tests were not rigorous enough?
For example, the test for “sovereign shock” is said to affect only the value of government bonds that banks mark to market, but what about the far larger proportion of government debt that is held in banking books? There are also question marks over the capital hurdle, with the most adverse scenario that banks need to reach a maximum Tier 1 capital ratio of at least 6% by end 2011. Moreover, there have also been reported divisions within European Union (EU) members about how much information to divulge. EUR has also ready lost ground over recent days but the currency could face much more selling pressure into next week if the tests are found to lack credibility.
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