FOMC Statement/Bank Stress Test Results May 4th

29 April FOMC policy statement

The run-up in US equities and selloff of the USD in front of Wednesday's FOMC meeting seemed to be partly fueled by speculation that the Fed would elect to increase its asset purchase program and speculation that next week's US bank stress test results will show that most major US banks have enough capital to weather future losses. The Fed reaffirmed its commitment to its current asset purchase plan and indicated that the pace of the US downturn has slowed. In its policy statement, the FOMC elected to hold rate policy steady as expected and says that while the economy has continued to contract, the pace of contraction appears to be somewhat slower. Household spending shows signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth and tight credit. The economic outlook has improved since March but will likely remain weak, and inflation remains subdued. That FOMC went on to say that it will continue to monitor the size and timing of its asset purchases and reaffirms its plan to buy up to 300 billion in treasuries by the fall. With commodity prices under pressure, inflation risk is not a near-term concern for the FOMC. The Fed says that that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term. Interest rates are expected to remain low for an extended period. The FOMC will have to lay out plans for an exit strategy from quantitative ease at some point in the future and begin raising interest rates as the economy improves but the Fed did not address this issue in today's statement. The USD rebounded after the release of the FOMC statement on buy rumor sell fact and modest disappointment that the Fed did not increase the size of its asset purchase plan. The Fed statement that the economy is weakening at a slower pace should contribute to improving risk appetite and limit the USD rebound. US equities rallied to new highs for the day after the release of the FOMC policy statement. The next hurdle for the markets and risk sentiment is the May 4th bank stress test results.

US bank stress test results due on May 4 th

The results of US bank stress tests are due for release on May 4th. According to a Wall Street Journal report, Bank of America and Citi may need to raise more capital. Bloomberg news reports that 6 of the 19 largest US banks require additional capital. Treasury Secretary Geithner has indicated that US banks that need new capital may elect to convert preferred shares to common equity. Geithner also said that the banks can try and raise new capital or seek additional government bailout money. The Treasury reported last week that there is only 109.6 Billion of the 700 Billion TARP funds remaining that can be tapped by US banks. In the current political climate if US banks seek more bailout money it's not assured that Congress will approve the request for additional funds. The Treasury hopes that the stress tests will offer transparency and help restore confidence in the banking system, but the results of stress tests present significant risks because of the low-level of remaining bailout funds and the difficulty in communicating what the results of the stress tests may mean for the long-term health of the US banking system. An IMF report warns that the total global losses of toxic assets and securitized debt may top 4.1 Trillion. The impact of the bank stress test results will hinge on whether the results help to extend the current recovery in global equities and risk appetite. As the FOMC statement notes, credit markets appear to be opening. LIBOR rates have fallen to their lowest level since last September. The decline in LIBOR rates suggest that the credit markets tensions are easing. If LIBOR rates continue to fall this may offset near-term concerns about the need for additional capital for a number of US banks. The USD may experience increased selling pressure after next week's release of the bank stress test results.

By Michael J. Malpede

Easy Forex

Michael J. Malpede is Chief Market Analyst with Easy-Forex® and has previously been featured on Bloomberg TV, Bloomberg radio, Reuters, MarketWatch, Wall Street Journal, Chicago Tribune, Chicago Sun Times, Toronto Star and Nikkei press. In analyzing the markets, he draws from 29 years of Foreign Exchange Research as a Foreign Exchange Analyst.

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