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Credit Insights

Will the European Bank Stress Test Stress the Market?

The credibility (or lack thereof) of this week's results is the next major event that will affect the global credit markets.

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The release of the European bank stress test results later this week, and the market's reaction to their credibility (or lack thereof) is the next major event that will affect the global credit markets. Over the past two weeks, credit and equity markets have improved, and the market appears to be pricing in a positive outcome from the tests. This past week, the Morningstar Corporate Bond Index tightened 9 basis points to +175, the tightest level since mid-May. High beta credits, financials in particular, outperformed. While domestic credit continued to outperform European credit, as we first opined in late May, we are at a near-term inflection point..

If the market believes the European bank stress tests are credible and European banks raise additional capital, we expect credit markets will overall improve significantly and European credit will tighten further and faster than domestic credits. If the stress tests are not deemed credible by the market, we expect credit spreads to widen, with the weakness in Europe more pronounced than in the U.S. There is not enough clarity as to the design of the stress tests and the amount of information that will be released to form an opinion on the market's likely reaction. For example, we have seen estimates for the amount of capital that European banks will need to raise range from EUR 30 billion to EUR 100 billion.

David Sekera does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.