Euro Zone Update: Don't Stress the Stress Tests

Stress Test Update: The latest indication is that next Friday the results of the European bank stress tests will be reported in some aggregate (perhaps country level) with details for individuals banks expected in the following couple of weeks. This may disappoint those who were anticipating some closure on 23 July.

European Financial Stability Facility (EFSF): We have argued that the 750 bln euro package announced in late May was largely about shock and awe. That the third that was to come from the IMF is simply a what if throw-away number that has not basis in reality. The IMF does not make blanket regional loans. Specific countries have to apply/ make specific requests and a specific program is worked out. Another 60 bln euros was to come from the EU and that status of this is not clear. So that leave 440 bln euros for the EFSF, assuming Slovakia gives its consent. But that 440 bln euros seems to exaggerate the size too. As a German paper reports today, in order to achieve the highest rating on the bonds it may issue, the EFSF must secure greater guarantees than loan amount. The initial agreement was 20% more guarantee than loans. That would reduce the 440 bln euros to about 365 bln that can really be loaned out.

Spain: The central bank of Spain reports that Spanish banks dramatically increased their borrowing from the ECB last month. June borrowings average 126.3 bln euros, which is an almost 50% increase from May. Spanish banks have not come to the market with new bonds for two months. The sovereign faces a large redemption later this month but appears to have secured the financing earlier. Spain, like the other periphery countries do not have significant redemptions for the remainder of the year. This could see the focus shift back to the private sector. That said, as we noted yesterday, some of the sovereigns are still receiving a greater credit rating than our models would suggest is warranted. We see Spain as vulnerable to a downgrade, with Fitch the most likely candidate.

ECB Money Market Operations: A new reserve period begins today in the euro zone. Banks had a little more than 50 bln euros on overnight deposit with the ECB. Typically banks tend to front load their reserve requirements, so look for overnight deposits to gradually increase. Meanwhile note that the euro libor slipped a little for the first time in near five weeks.