European Bank's Stress Test has been highly publicized and debated topic. The intrigue and mystery of the test has investors and common public on the edge of the seat. Finally, we may have an answer to this question at the end of the week. The European authorities will release the highly anticipated report on Friday at 12:00PM EST or 16:00 GMT. Together there will be 91 banks tested, representing roughly 65 percent of the combined European banking sector.
So the question remains, what will happen to the Euro after the release? Well, let's digest some positives and negatives which can originate from the incredibly thrill seeking announcement.
Taking a step back and looking at previous reactions of stress test elsewhere, we notice an important correlation. Once the stress test was conducted in the United States, the US economy once more gained a breath of confidence. The stock market turned around in the positive direction, while the economy began its stage of recovery. Confidence, or lack there of, is the a great driver. Despite the US economy turning around in positive direction, the Dollar went in complete different way. The factor to it was a renewal in risk appetite. The Euro gained as riskier assets were in demand. Now the same scenario holds true, what could be more risk positive then an exceptional result for the European Banks.
Looking at the technical picture of the Euro, we notice that the upcoming anticipation has edge the Euro to the highest level in over two months. The technical resistance level of the Euro against the greenback stands at 1.30. If the level is breached due to a positive results, expect the Euro to have legs to walk over hanging psychological level.
Despite the possibility that the test could be a positive result for the Euro, some threats are materializing like a hurricane of the coast. If this hurricane gets more hot air, the Euro could destroy a tremendous amount of progress it has done since hitting this year low's of 1.19.
The first uncertainty lies in the criteria of the test. Investors do not want to see a simple Pass or Fail methodology. Investors need answers, they need reassurance. The less stringent the test, the bigger probability that confidence in the banks will wane. The following may have a superbly negative impact on the Euro as investors will run for cover into US Dollar or Japanese Yen.
Masking this type of a test is never the answer. However, the European authorities might just do that. Judging better situated banks with those that are more prone to the downside risk will be inefficient. The banking system and each bank tested needs to be on individual basis and not the aggregation of the whole system. A contagion affect is highly probable in the European system, in such case the solidity of individual bank will weight more than the system itself.
The results of course might come negative. Negative stress test will be nothing short of dire situation for the Euro. So far, rumors have flew around that Greece's haircut on debt might increase from 17 percent to 23 percent. In addition, Spain might be another country to experience a haircut affect. Furthermore, the timing of the release is not right for the Euro. The currency has rallied tremendously over a course of two month and a profit taking scenario might originate as investors do not want to be exposed to weekend's uncertainty. Never forget the golden rule of investing, “Buy the Rumor, Sell the Fact” mentality might take hold.