Our initial reaction to the stress tests is disappointment but we think the trade is to buy EUR/USD with a stop at the session lows. We would have liked to see a better stress test that included all the sovereign debt on banks books (rather than just the trading book). But what’s priced into the market? There is a €700 billion backstop on sovereign debt in Europe so there will not be a default. With economic data improving the market is pricing in a diminished chance of a double-dip recession so that is unlikely as well. The euro is down 60 pips to 1.2832 on the slightly damaged credibility of the ECB but we thought the U.S. stress tests were a sham as well (they forecast 9% unemployment in the adverse scenario). The market will turn its focus back to European and U.S. fundamentals and we believe that will reflect positively on EUR/USD in the short-term. Stop at the session lows but look for an eventual rally to 1.32. Remember that in a sentiment-driven market anything is possible so stay nimble.
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