Wednesday, November 23, 2011

Stress Tests for Banks, More Bad News from Europe, and Weakness in China

Income and Spending: Plenty of news this morning, much of it raising serious concerns, so let's start with "pretty good" news.  After declining for 3 straight months, disposable income adjusted for inflation rose in October.  However, growth in consumer spending slowed down to 0.1%, increasing the personal savings rate to 3.5% (still a very low rate).

Stress Test: Late yesterday, the Fed announced a new stress test for the 31 largest banks.  The test involves determining if the banks will be able to handle various severe economic and financial  situations including (1) a recession similar to 2008-2009 when economic growth shrank in excess of 8% for a quarter at an annualized rate with an overall decline of 5% before beginning a recovery; (2) a worsening of the European debt crisis; and (3) a 52% decline in stock prices over the next year.  Banks that don't pass the test will be required to boost their capital.  The Fed wants to ensure that US banks will be ready for any potential crisis so as to limit the damage to the economy and avoid a repear of 2008.

Europe: Speaking about Europe, add Germany to the list of countries having difficulty selling its bonds.  At an auction this morning, Germany had to pull just over one-third of its bond offering due to a lack of interest (rather than pay a significantly higher yield).  Given that Germany is supposed to be the risk-free benchmark in Europe, if investors perceive risk in Germany, the debt crisis is reaching a new stage.  Meanwhile, the aggregate purhcasing manager's index for Europe continued to indicate a contraction in European manufacturing.

China: Finally, China's purchasing manager's index came in at its lowest level since 2009 (48), indicating contraction in its manufacturing sector.  This raises concern as to whether China will experience a soft or hard landing in the months to come.  Given sluggishness in the US and extreme weakness in Europe, a significant slowdown in China would add to risks to the global economy.