Market Overview

Fed to Start Stress Tests Again: How to Play It

FOMC Vice Chairwoman Janet Yellen said that the Federal Reserve will start a new round of bank "stress tests" in "a couple of weeks", as there are concerns about the European debt crisis, and how it might affect the U.S. financial system.

In comments captured by Reuters, Yellen said, "Concerns about European fiscal and banking issues have contributed to strains in global financial markets that pose significant downside risks to the U.S. economic outlook.

She went on to say the Federal Reserve is "monitoring European developments very closely, and we will continue to do all that we can to mitigate the consequence of any adverse developments abroad on the U.S. financial system."

This is not the first time the Federal Reserve has conducted stress tests. It has done them every so often since the 2008 financial crisis started.

The concerns over Europe are real. The Italian bond market nearly collapsed earlier this week, and the yield on Italian ten year debt is still well above the 6% comfort level. Italy can sustain yields above 6% for a period of time, but how long is anyone's guess.

The markets, and the Federal Reserve are right to worry about Italy, and Europe as a whole. The PIIGS (Spain, Italy, Ireland, Portugal, and Greece) have a combined debt level approaching $5 trillion, and there is no solution for how to keep these countries solvent, much less return them to pro-growth economies. The EFSF has been nothing short of a disaster, there is no Eurobond, and Germany and France can not pay for everybody forever. It just isn't sustainable.

Greece has already started its austerity measures, Italy has passed them, Ireland is working with its own set of measures, Portugal has already been bailed out, and Spain will likely need some kind of assistance in 2012. Europe is nothing short of a mess at this point, and it seems like it will be a long time coming before this any kind of order in the European Union.

The world can not continue to worry whether Europe is going to crash, and additional stress tests are the right way to go. When the tests were first enacted in 2009, many thought they were soft, but that was ultimately proven wrong. The Fed has done a valiant effort of making sure the U.S. banking system is largely healthy, and the banks that are not healthy (hello Bank of America (NYSE: BAC), how are you?) have not been able to raise their dividends and are being pressed to raise capital in anyway.

The stress tests will occur in "a couple weeks," and the results will definitely be market moving. Names like Goldman Sachs (NYSE: GS), J.P. Morgan (NYSE: JPM), Bank of America, Morgan Stanley (NYSE: MS), and Citigroup (NYSE: C) will all be in play when the results come out. Any positive surprises could help some of the more beaten down names, while negative surprises could sharply damage some of the reputations of the banks.

ACTION ITEMS:

Bullish:
Traders who believe that some of the beaten down banks will get a pop on favorable results might want to consider the following trades:

  • The major names that have perception problems are Goldman Sachs and BoA. If these two banks are found to have no more problems, shares could see a boost.

Bearish:
Traders who believe that Europe is a bigger issue than the banks are currently letting on may consider alternate positions:

  • Consider shorting the weaker banks, as this could be the final nail in the coffin for these names.

Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

Posted-In: Federal Reserve FOMC Janet Yellen ReutersLong Ideas Short Ideas Media Trading Ideas Best of Benzinga

 

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