Stress Test Fears Spark Selloff in Currency Market

05/06/2009 11:41 am EST

Focus: FOREX

Boris Schlossberg

Managing Director of FX Strategy and Co-Founder of BKForex LLC, BK Asset Management

Overnight reports that Bank of America may need as much as $34 billion in new capital in order to meet the stress test requirements have spooked the currency markets, triggering waves of risk aversion flows throughout the Asian session. According to reports by Bloomberg and Reuters, BoA will need another massive infusion of capital in order to achieve the government’s minimum standards for balance sheet health.

Although BoA may be a unique case given the fact that it has had to absorb Countrywide Financial and Merrill Lynch, both of which still hold massive toxic debts on their books, this news raised fresh concerns that the US banking sector as a whole may be in need of more capital than the market originally thought. According to latest reports, ten out of the 19 banks tested will need to raise additional capital and will have to meet the more stringent requirement of having tangible assets of 4% of equity, rather than 3%.

After several weeks of positive economic data across the G10 universe, which fuelled a rally that pushed some high beta currencies to their yearly highs, today’s dour news triggered broad profit taking in EUR/USD, GBP/USD, and AUD/USD. In Australia, even the much better than expected retail sales results were of little help as the Aussie slipped below the 7400 figure.

Nevertheless, despite the fresh concerns over the health of the US financials, the liquidation has been controlled and contained for most of last night, with EUR/USD finding support at 1.3250, cable at 1.5000, and AUD/USD at .7350. If the overnight economic data proves positive and no further stress test leaks hit the screens, risk appetite may return as the day progresses. However, today’s revelations have clearly dampened investor enthusiasm and further gains in the high-risk currencies are likely to be difficult for the rest of the week.

By Boris Schlossberg of GFTForex.com

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