So what U.S. banks will be the winners—and which the losers—when the Federal Reserve releases Round 2 of its stress test data on March 26?
Yesterday’s Round 1 looked at 30 big U.S banks to see which met the Fed’s capital targets in the event of a U.S. financial and economic crisis. Only Zions Bancorp (ZION) railed to meet the Fed’s target. In the event of a crisis Zion’s capital ratio would fall to 3.5%. That’s below the 5% minimum set by the Fed.
Today Wall Street has moved on to look at next week’s test. On Wednesday the U.S. central bank will announce which of the 30 banks on the list have won approval for their capital plans for 2014. Banks winning approval will be able to go ahead with plans for share buybacks and increased dividend payouts. Banks that fail to win approval will have to put buybacks and dividend payouts (or at least increases in dividend payouts) on hold while they resubmit plans for raising capital and for distributing it to shareholders.
Zions Bancorp isn’t the only bank in danger of getting a “No” from the Fed next week. Bank of America (BAC), Morgan Stanley (MS), Goldman Sachs (GS), and JPMorgan Chase (JPM) all came in with capital ratios below 7% in the Fed’s test. That puts them relatively close to the 5% limit and might lead the Fed to veto their plans for buybacks and dividend increases. Last year the Fed gave an initial “No” to both Bank of America and Citigroup (C). (Citigroup is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ )
The capital ratio under the Fed’s stress test isn’t a straightforward indicator of how the Fed will rule. The central bank will also consider the capital distribution plans submitted by individual banks and how much capital buffer any plan would leave. For example, the consensus among Wall Street analysts is that the Fed will approve the plan from JPMorgan Chase because it projects distributing only about $10 billion from the bank’s $17 billion capital buffer above the Fed’s stress test minimum.
The consensus also points to Bank of America as the closest to a potential veto. Read more
The financial markets didn’t like what they heard from the Federal Open Market Committee and Federal Reserve chair Janet Yellen this afternoon.
Treasuries moved lower across the yield curve with the two-year Treasury yield closing at a two-month high; the yield on the five-year rising to 1.6975%; and the yield on the 10-year Treasury closing up 9 basis points to 1.725%. That took the yield on the 10-year benchmark for mortgages above the 50-day and 100-day moving averages. (Remember bond yields go up when traders sell bonds and bond prices fall. So we’re talking about selling on today’s news.)
But what exactly didn’t the markets like?
Yes, the Federal Reserve did indeed continue to reduce its month purchases of Treasuries and mortgage-backed securities. The Fed cut another $10 billion a month from the program to bring what was once $85 billion a month in purchases to $55 billion.
But this was widely expected.
The Fed also threw out its own guidance of keeping short-term rates at the current 0% to 0.25% range until the unemployment rate hits 6.5%. With the unemployment rate near that level now, all of Wall Street expected the Fed to abandon that target. And so the central bank did—even if it didn’t replace it with anything concrete. The Fed will instead, Yellen said, look at a wide range of information including unemployment, inflation expectations, and financial markets.
Not terribly satisfying as guidance but, again, not unexpected.
So, then, where was the problem? Read more
New Federal Reserve Chairman Janet Yellen delivered her first congressional testimony today in front of the House Financial Services Committee.
And financial markets liked what they heard. As of 1:30 p.m. New York time the Dow Jones Industrial Average was up 1.23% and the Standard & Poor’s 500 1.03%. Germany’s DAX Index closed up 2.03% on the day and in Asia, where markets closed well before Yellen started to talk, Japan’s Nikkei 225 Index was up 1.77%, Hong Kong’s Hang Seng was up 1.78%, and the Shanghai Composite was ahead 0.84%.
Yellen stressed continuity with former Fed chairman Ben Bernanke’s policies. The Fed would continue to reduce its purchases of Treasuries and mortgage-backed securities at a speed dependent on the economic data. The slow pace of job creation in December and January was certainly disappointing but, Yellen cautioned, two months of data weren’t enough to bring a change in the central bank’s taper policy. The Fed’s Open Market Committee doesn’t meet again until March, she noted, and that will give the bank another month of data to examine.
Most important Yellen successfully—for the moment—addressed the market’s anxiety about the falling unemployment rate. Read more
Today, January 29, big, surprise interest rate increases from central banks in Turkey, India and South Africa didn’t stabilize global markets. A decision on Wednesday by the Federal Reserve’s Open Market Committee to reduce its monthly buying of Treasuries and mortgage back securities by another $10 billion a month added to the downward bias. The U.S. Standard & Poor’s 500 fell 1.01%. The German DAX slipped 0.57%. Among emerging markets the Turkish stock market dropped by 2.29% and stocks retreated 0.59% in Brazil. In Asia Japan’s Nikkei 225 was down 3.33% as of 10.40 p.m. New York time.
If the Turkish central bank thought a huge interest rate increase would shock and awe investors, it was disappointed. After avoiding an actual interest rate increase in the face of pressure from the government, Turkey’s central bank used an emergency meeting to raise its benchmark seven-day repo rate to 10% from 4.5%. The move is intended to 1) restore confidence in the central bank, 2) stop a run on the Turkish lira, and 3) reduce an inflation rate running at 7% and threatening to move higher. The lira was down 30% against the U.S dollar in the current rout and it now trades at a record low against the U.S. dollar.
The Reserve Bank of India also raised interest rates yesterday with an increase in the benchmark rate to 8% from 7.75%. Inflation in India has been running near 10% and the country’s reliance on cash flows from overseas to balance its current account deficit has kept pressure on the rupee.
South Africa joined the interest rate parade yesterday with the South Africa Reserve Bank hiking its benchmark repurchase rate to 5.5% from 5%. The increase was the first for the bank since 2008. Inflation in South Africa climbed to 5.4% in December. The rand is down 6.8% so far in 2014.
The problem with interest rate increases like these is that they’ll only work to stabilize financial markets and currencies if 1) investors and traders think the most recent move is the last or near the last in a series of interest rate increases, and 2) if investors and traders find the rates on offer compelling enough to turn cash outflows (into dollars) into cash inflows (into lira, rupee, and rand.) Read more
Given how sensitive to any news that hints at slower economic growth in the U.S. or any other major global economy, I expect financial markets will be nervous tonight and tomorrow ahead of a full day of economic news.
Over night China will release December data on exports and imports. The worry, of course, is that the numbers will show flagging export growth—which would mean, the markets will argue, that the global economy is slowing—and slowing import growth—which would cast doubt on government plans to shift economic growth from exports to domestic consumption. Numbers from Australia today showing that in November Australian imports fell by 1% and exports were flat haven’t helped calm market worries about the Chinese numbers. (The Australian economy has stumbled lately so it’s not clear if this data says anything about any other economy than Australia, but in the current uncertainty every data point gets counted.)
Also overnight investors will get retail sales numbers from the EuroZone for November. Retail sales fell 0.2% in October. After a drop of 0.6% in September and the release yesterday of a weaker than expected Purchasing Managers Index reading for Germany’s service sector in December, financial markets are likely to see another monthly decline in retail sales as evidence that the European recovery is stalling out
And finally, tomorrow afternoon at 2 p.m. Eastern Time the Federal Reserve will release minutes from its December 18 meeting. You know, the one where the Open Market Committee decided to begin tapering off its monthly $85 billion in asset purchases. You can expect that traders and investors will try to wring any clues that they can from these minutes about what the Fed thinks the likely course of the economy will be
In all these cases I think the big danger is that financial markets will over-interpret the available data in an attempt to end the current uncertainty about growth rates in the U.S. and global economies. I understand the impulse—I’d certainly like to know where the economy is headed and at what speed. But while the kind of data we’ll see tomorrow is sufficient to move asset prices in the current state of anxiety, I don’t think these data points in these particular data series will be sufficient to tell us what we want to know.