The U.S. banking stress tests are released soon, and the delivery of the results may have massive ramifications for equities and for the Usd. Have you wondered how ‘safe’ the banking system now is? Do you have any idea on how many U.S. based banks make the global top 50 ‘safest bank’ list?

The reality seems to be that U.S banking, when compared to overseas counterparts, is anything but ‘safe' and that the flight to Usd safety may reverse more quickly than it started if equities find buyers. Risk tolerance investments in the financial sector may drift towards overseas banks instead of the excess going from Treasuries to the U.S. based financial sector. The market may set the scenario for equities move higher and new the global investment rule book push excess funds to the ‘safety’ of overseas banks, a double whammy for the Usd.

The widely anticipated banking stress test results will be made public in the first week of May, and will no doubt create volatility in the market place as the figures and information are finally made public. Forex traders will be interested to see the impact on the Usd, and where things go from here.

“The flight to safety of the Usd whilst the credit crisis unfolded may have been overplayed ”said Trade Team “and it could be a very rocky road for Treasury note values, and by default the Usd, over the coming quarters. Global markets do not see the U.S. banking sector as safe at all when compared directly to its overseas peers, and in reality the flight to safety may now have serious questions to answer” they said.

“By stress testing the U.S. banking system the Administration are testing a very weak industry that is a long way from the safety of European, Australian, and to some extent Canadian, Middle Eastern and Asian counterparts it seems. The results may be good for the Administration to pontificate about, but may not help in any way the dollar to hold technical support areas that are close to current valuations”.

A Quick History Of The Flight To Safety

2007 started the de-valuation of toxic assets after the rating agency downgrades of sub-prime financial instruments that were based on overstated/overleveraged assets. The consequence was that banks de-valued their balance sheet, and that instigated a move lower in equities that soon became a rout as the markets moved from the risk of stocks to the ‘safety’ of bonds; moving from stocks to bonds historically increases the value of the dollar.

July to November 2008 saw massive long-dollar positions built in the form of reserves, notes, and bills by overseas investors, central banks, and sovereign wealth funds. The safest form of bond is deemed to be U.S. Treasury notes, and as such the dollar strengthened as Treasuries were bought and speculative oil and equity positions were sold. The dollar buying moves were strong, and backed with increasing volume levels.

The Move Away From Safety

Treasury Income Data however has started to show that the net flow of overseas investment to the U.S. is not enough to fund the U.S. current account and trade balance, and as such more Treasury notes will be printed for the Federal Reserve to purchase in an effort to raise cash. In 2009 global equity markets have found a base of sorts, where the massive equity selling binges have stopped and a semblance of normality has returned to intra-day price activity in stocks.

“The S&P looks to have based around 750, and now floats in a 100 point channel, at the same time as the dollar index has traded in a range between 83.00 and 89.00” TheLFB Team said. “It is abundantly clear that the dollar and the S&P futures market are linked in a mirror image move; the days that equities are bought are the days that the dollar declines and vice versa”.

“Equity markets will only make sustainable moves on good volume once the financial sector is bought, but the XLF (exchange traded fund for the financial sector) is showing that banking is still definitely not the flavor of the month. The sector is struggling to break the one day up, one day down routine, and is fast becoming infamous as the sector that will easily move the equivalent of one month’s value in a day” TheLFB Team said.

The easiest way for the financial sector to move forward, and to lead equities to higher ground and by default send the dollar lower, is if the Stress Test results are delivered in a positive way. Not that the results are expected to be positive, that will be a lot to ask, but that the spin is played the right way. The reason for that being critical is that the banking sector in the U.S. does not compare in any way to the ‘safety’ of overseas banks in regard to long term bank deposit and foreign exchange currency ratings from Standard & Poors, Fitch, and Moody’s.

“The reality is that U.S, banking when compared to overseas counterparts is anything but ‘safe', and the flight to Usd safety may reverse more quickly than it started if equities find buyers, and risk tolerance investments in the financial sector drift towards overseas banks instead of the excess going from Treasuries to the U.S. based financial sector” TheLFB Team said. “We may see the scenario that equities move higher and new global rules push excess funds to the safety of overseas banks, a double whammy for the Usd”.