Stress Test Speculation Creates Volatile Situation for U.S. Dollar

U.S. banks received their preliminary results from the Fed’s recent stress tests and now have 10 days to address any major capitalization problems.  This 10 day period opens the door to the possibility of wild speculation over which bank has sufficient capital and which does not.  Any hint of substantial banking problems is likely to send Forex traders flocking to the U.S. Dollar.

Friday was “Stress Test Day” and the 19 major banks analyzed by the Fed received the preliminary results of the recent stress tests performed by the top bank. These results will let the banks know what they need to do to achieve stability and where they are at risk. Some will be told they need capital now. Others will be informed of future situations where they would need to shore up capital requirements.

Only preliminary results were released with the actual results coming out on May 4. It is kind of like getting a report card from your teacher and having 10 days to fix the grades before your parents get to see it. Of utmost importance is secrecy at this time. The Obama Administration does not want the release of these preliminary reports leaked in order to prevent excessive speculation in a bank’s stock or a run on a bank.

This 10-day period before the release of the actual numbers is to prevent a shock to the banking system. Of course speculation over who is sound and who is in trouble may plague the markets from now until May 4, but that is why we have markets. There seems to always be someone willing to take the risk.

If the numbers are too good then no one will believe the Fed. If the numbers come out bad then investors may head for the hills. Either way the next 10 days are likely to be some of the most volatile we’ve seen since the fall 2008. There is likely to be speculation on both sides of the market. At times the herd will chase the good bank stocks and repel the bad bank stocks. The only thing that is certain is that no one will know the exact results from the stress tests until May 4. Any moves that take place before then will be all speculation.

The banks received their preliminary reports early in the day while the Fed waited until late to say that the top 19 U.S. banks need to hold a “substantial” amount of capital above regulatory requirements. The use of the word “substantial” is where the speculation is likely to begin. What is substantial and which banks meet this requirement will be the questions asked by many traders and investors over the next 10 days.

Since the U.S. Dollar is still the world’s reserve currency and the markets remain sensitive to banking issues, the Greenback could see quite a lot of buying if there are any signs of new banking sector trouble. One of the major concerns among traders will be that one or more of the larger U.S. banks receives the scarlet letter and gets deemed a failure.

Next week could prove to be quite volatile.  Early in the week is the huge Treasury auction which could pressure the Dollar versus the Euro.  The wildcard, however, is going to be the market’s reaction to speculation regarding the stability of the U.S. banking system.  Don’t be surprised by an explosive two-sided market.