Forex - Apprehension Over Stress Tests Cause Short Term Correction

The optimism surrounding “green shoots” has taken a back seat to concerns over the financial sector. However, the equity markets have reversed early losses and US stock futures are pointing to a higher open. Commodities are following what seems to be a rapid reversal of negative sentiment with gold and crude currently trading higher. The USD and JPY, both primary recipients of the risk aversion trades, are now coming under significant selling pressure. The EURUSD rallied off the 1.2900 level and is currently trading at 1.2957, while the AUD is making daily highs against the USD after yesterday’s weakness. Overall we do not see the recent rash of risky asset selling to be the reversal of the last month’s trend, but just a much needed short term correction (in light volume). Despite the signs that global growth stabilization are spreading (although Market News reported that the IMF will downgrade global growth significantly from its forecast presented at last month's G20), and corporate earnings printing higher then expectations, the concerns over US ‘stress tests’ has sparked this most recent bout of risk-reduction. US banks' have been trying to convince investors of their liquidity positions but ongoing worries over solvency are hurting the sector and confidence. Sentiment was also hurt after a major Bank of America reported strong profits but warned of worsening conditions in the near future and the need to increase provisions for credit losses. In addition, rumors that the treasury and regulators are arguing about how to actually release the results scheduled for May 4th give the impression that there are some dark spots. US officials are well aware of the systemic risk should even a few of the banks fail to pass, especially since the methodology of the stress test have not been fully disclosed to the markets satisfaction. Yesterday, Fed's Kohn warned that while there were signs of a recovery in the US, house prices remained weak and a restructuring of the US car industry would add to problems in the economy. In Australia, the RBA today released the minutes to the April Board Meeting, when the bank delivered a 25bp rate cut taking the cash rate to 3.00%. Although the minutes highlight a Board being divided over whether to cut rates by 50bp or hold, which likely resulted in the 25bp compromise, the tone of the minutes now leads us to believe the RBA will be on hold in the coming months. Despite downgrades in the economy Australia still is fairing better than developed markets peers and should keep the AUD supportive. The Bank of Canada will deliver its rate announcement today and markets are expecting policy makers to hold at 0.50% and limited comments on QE to emerge. As pressure to exploit the unconventional options increase, we expect to see the CAD come under selling pressure.