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The financial sector might still face a difficult period ahead, TheLFB-Forex.com Trade Team notes, as the U.S. administration is trying to impose stricter rules, while a large number of banks may still have to face further sub-prime/credit-crisis write-downs.

Consequently, the rating agency S&P downgraded 18 U.S. banks (of which five were moved into the naughty corner; to default levels) after earlier this week Moody’s downgraded another 25 Spanish banks.

Moreover, both the ECB and the S&P issued a warning this week that European banks might continue to faces losses this year , and next, continuing the trend started in 2008. According to the ECB, losses in the European financial system might reach $280 billion by 2010.

The credit crisis showed that risk is spread systematically throughout the financial system (remember now, “Financial innovation is good”), and now these losses are likely to be reflected in the U.S. bank balance sheets. But for now, U.S. financials are sheltered behind the law that allows them to value illiquid assets (toxic waste) using the bank’s own valuation models.

Additionally, the new financial regulations that President Obama’s team is trying to impose will probably reduce, even more, the sectors’ profit margin and will inflict tighter regulation; something that investors will certainly not like.

As such, TheLFB-Forex.com Trade Team notes, the strong uptrend that the financial sector experienced lately might come to a halt, after the XLF index outperformed the broader S&P 500 over the last three months of trading. Moreover, it is hard to believe that the U.S. markets can advance without the financial sector in the front line, especially in the current market circumstances.

Therefore, the U.S. equity market may well spin its wheels through the summer, as the financial sector re-alignment continues to take place; something that stock market bulls had hoped was already baked into current valuations.