Bank Stress Tests, Poor European News, China Still Likes Treasuries

The market appears to have so much to worry about that it is having difficulty choosing which to focus on. The immediate interest is on the details of the European bank stress tests. The criteria is expected to be announced by the Committee of European Bank Supervisors.

The market is keen to know if the banks are string enough not only to withstand weaker growth and higher unemployment, as was the case of the stress tests on US banks a year ago, but also if they can cope with problems rolling over current funding and a potential sovereign default. There has been numerous press reports warned that the stress test may reveal serious capital requirements. That said, officials from numerous countries seem to be playing down the risks and highlighting the relative health of their banks.

While the focus of many observes has been on the German Landesbank sector and the Spanish Cajas, we note that late yesterday Ireland’s National Asset Management Agency—the “bad bank” created to manage the troubled real estate loans – indicated that it now expects only 25% of the 81 bln euro (~$102 bln) in loans it has purchased will be income-producing. This is down from its previous estimate of 40%. Finance Minister Lenihan admitted that NAMA discovered “a horrific picture within the banking system.” NAMA said it may lose as much as 800 mln euros over its life time under a stress scenario outlined yesterday. NAMA’s central projection is for a profit of 1 bln euros, which compares with a estimate at the end of last year of a 5.5 bln euro profit.

There were four pieces of economic news from Europe today and all were disappointing.

First, the UK’s June BRC shop prices rose 1.5% vs 1.8% in May for their slowing pace in 3-months and the KMPG survey reported that job growth slowed for the third consecutive month. For sure, these are secondary release. The BOE’s MPC meeting kicks off today and no change in policy is expected. However, it will be recalled that there was one dissenter last month (Sentence). The press and markets have tended to focus on the resilience of British price pressures, even as growth has surprised on the downside. Although it is not expected yet, should another MPC member join Sentance in dissenting, it would likely generate a strong market reaction and likely positive for sterling and negative for short-term UK rates.

Second, France reported a larger than expected May trade deficit. The 5.5 bln euro shortfall compares with a consensus forecast of a 4 bln euro deficit after a 4.3 bln shortfall in April. It is the largest monthly shortfall since October 08 and is a function of a 1.1% decline in imports and a 5.2% decline in exports. The decline in exports seemed concentrated in manufactured goods, oil and refined products, and transportation goods.

Third, Norway reported disappointing manufacturing data. Output fell 0.9% in May. The consensus had expected a 0.3% gain. The central bank had warned that economic momentum had slowed. The krone has been punished for the disappointment and the euro has gained a little more than 0.5% against it today. The euro is flirting with the NOK8.10 resistance area and a convincing break could spur a move toward NOK8.20.

Fourth, German manufacturing orders fell by nearly as much as they were expected to rise. The 0.5% decline in May manufacturing orders contrasts with expectations of a 0.3-0.5% rise. The April series was revised higher to 3.2% from 2.8%. While it may be best to consider the two months of data for this volatile series, the breakdown does play on the theme of economic weakness in Europe. Non-EMU orders rose 1.8%, (+6% in April), while EMU orders fell 3.3% (-0.1% in April).

China’s reserves remain in the news. News that the PBOC had stepped up its purchases of JGBS captured the market’s imagination earlier this week and the PBOC was quick to note that it has not abandoned the euro. Today, the manager of the PBOC’s reserves (SAFE) indicated that Us Treasuries remain its key asset. It noted the relative safety, liquidity and low transaction costs as important attributes. In the past, there had been talk of China boosting its gold reserves, but the officials comments today played this down, noting the large price swings and the lack of a yield stream as deterrents.