Two items today, which are more closely intertwined than one might think at first glance:
#1: The first round of Federal Reserve bank stress test results, which included the novel WUV-shaped COVID Crisis recovery analysis, were out today. This was the analysis we highlighted in yesterday’s Data section.
Here are the results with regard to how much capital the US banking system would have under W, U and V scenarios, as posted by the Fed today (links to their full report below):
What all this means:
- Focus on the 25th percentile column (on the left). That’s where the weaker US banks sit, and the number here (CET1) is their Tier 1 capital ratio. The magic number is 4.5% – the minimum required by regulators.
- This year’s stress test shows an 8.0% ratio – all good here, even for the less well-capitalized US banks.
- But as our crack bank analyst friend has warned us, the W-shaped recovery scenario would be a tough test. He was right; under a double-dip recession forecast the lower quality banks get down to 4.8%.
Bottom line: although the Fed’s 2020 stress test does give the banks reviewed approval to pay dividends based essentially on current earnings, the COVID sensitivity analysis was enough for Governor Brainerd to dissent from that view. In her opinion it would have been better for the Fed to temporarily halt dividends at all large US banks, preserving their capital for what may be a rainy “W-shaped” day.
We’ll see how markets take this news tomorrow with respect to the bank stocks as well as any broader signaling effect. We read it as neutral to slightly negative, if only because seeing a Fed governor dissent on an important issue like big bank dividend policy shows an inherent lack of consensus at the central bank about the future US economic outlook.
#2: Continuing claims for unemployment insurance. The headline numbers out today were modestly positive, with 767,000 fewer American workers on the UI rolls. This is not, however, the entire story:
- We use the non-seasonally adjusted numbers because the scale of the dislocation in US labor markets is more important than seasonality effects and the adjustors for those skew the data materially.
The reality is that only 501,000 workers left the UI program last week.
- The number of workers receiving Pandemic Unemployment Assistance (PUA) rose by 1.6 million last week to 11.0 million. This is the program established by the CARES Act, which extends unemployment insurance to workers who would not typically qualify, such as business owners, self-employed workers and independent contractors.
Bottom line: the total number of American workers receiving unemployment rose (not fell) last week to a total of 30.6 million people, up 1.3 million from last week.
How this ties to the prior point and also matters to market psychology: right now both traditional UI and PUA pay an additional $600/week, but that bump over the normal $400-ish/week payment is slated to end on July 26th. Given the resilience of the US equity market even today, one must assume that investors believe these payments will be extended for many more months. Thirty million people suddenly seeing their income cut by 60% does not fit well with a market that trades for +20x earnings and an economy that has an uncertain future given recent COVID flare ups. Nor is it a good setup for bank stocks, especially given their less-than-stellar W-shape recovery capital ratios.
Summing up: while we agree with the market’s view that additional help is coming for unemployed workers, one can also envision a few choppy days in July before Washington comes to the same conclusion.
Fed Stress Test Results: https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200625c.htm
Latest Unemployment Insurance data (see page 4 for the data we cited above): https://www.dol.gov/ui/data.pdf