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… Well so far, nobody is really sure. Given that both Abu Dhabi and the UAE Central Bank have quickly come forward to assure markets of their support for the beleaguered Emirates State, then the financial impact should be quite minor. Certainly, there will be repercussions for Western lenders and there is no guarantee that Dubai’s ‘fairy godmother’ will stand behind its liabilities carte-blanche but equity markets are viewing the situation as containable.

The potential problem is any growth in concern over global Sovereign stability and the fact that CDS spreads have continued to widen suggests that even though things look calm on the surface, there is a lot of thrashing about below the surface. If things do begin to look a little dire, then expect the Dollar to come back into focus as risk aversion trades re-emerge.
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…with currencies largely unaffected in London trading although the Dollar edged stronger as market liquidity thinned out. The big movers were the CDS and equity markets with the cost of insuring against sovereign default leaping and equities dropping sharply, led by the banks perceived to have most risk out to the UAE region. Overnight analysis of the situation threw up only less certainty and none of the data produced has actually diminished the possible risk to global stability.

This morning, there has accordingly been a rush into risk averse investments ie the Dollar, with gold, oil and equities all dropping sharply as market participants both bank recent gains and hedge against further bad news. The ongoing Dubai restructuring story, combined with recent restructurings in Kazakhstan and Ukraine, raises questions over the quality of sovereign support for quasi-sovereign names. The risk is that in the aftermath of this, rating agencies take a less generous interpretation of sovereign support and we see a wave of quasi-sovereign downgrades. Investors will then demand a higher risk premium for holding assets of those quasi-sovereigns without explicit sovereign guarantees. Hence, developments in Dubai have broader market resonance and the CDS market has continued to react negatively with spreads widening dramatically, especially those of the less well thought of sovereign names.
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The USD has lost key resistance levels against the EUR, CHF and JPY hitting a 14 year low on the YEN. The Japanese authorities are not happy with current situation with the strength of the YEN hurting exports. Recently we have seen attempts from Japan to verbally intervene in the markets and threaten direct intervention- this has not stopped the rot. Similarly the Swiss National Bank has recently intervened on USD/CHF and EUR/CHF and rumours are circulating that the SNB are buying USD/CHF today. In addition the market is also talking of a potential bout of co-ordinated central bank intervention by the SNB, Bank of Japan, US Federal reserve and the European central Bank.
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The market was left somewhat disappointed this morning as UK revised third quarter GDP came in as expected at -0.3% from -0.4%. In the run up to the announcement the pound rallied higher against the USD and the EUR as a rumour circulated that the data would show an upward revision to -0.1%. Market talk lately has been frequently way off the mark and today was no different and it was a case of buying the rumour and selling the fact once the data was released. The pound jumped to 1.6727 against the USD and 1.1135 on the euro; post data it dropped to 1.6675 and 1.1105. Yesterday was a poor day for the pound as Mervyn King’s speech set its usual dovish tone leaving the door open for further stimulus; however the pound managed to hold above key levels of 1.10 against the euro and 1.65 on the USD.
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Today is a data packed calendar for the markets. Notably we kicked off with the German November IFO survey which came in stronger than expected; this has lifted the euro a little this morning after a bad start. Concerns have been rising again on the health of West LB in various articles which to some extent undermined the euro in early trading. The euro still remains locked on the target of 1.50 against the USD and we need to see a break of 1.5050 to forge a move higher. Overnight we have seen a swing back into USD buying as concerns over the state of the global banking system re-emerge. The S&P have again warned that nearly all of the major global banks lack sufficient capital to cover trading and investment exposure…Japanese stocks weakened as concerns grew that Japanese banks are set to sell more shares to replenish capital.
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After a good performance last week by the USD the market was looking to see if the fight back could be sustained. From looking at the markets this morning then the answer is no; EUR/USD is again pushing towards 1.50 and GBP/USD has recovered from 1.64 levels back to 1.66. Influence on the USD has arisen from Federal reserve Governor Bullard who recently made interesting comments on Fed policy. He said that it will be difficult for the Fed to hike interest rates if the jobless data continues to worsen or look fragile and also tellingly that the Fed should keep alive its asset purchasing programmes beyond the first quarter of 2010 to give policy makers flexibility. This is somewhat akin to the strategy of the BoE and the comments dampen the hopes of rate hikes and exit strategies from unconventional monetary policy measures and thus weakening the USD. Although the comments are not yet official strategy, they still lend an insight to potential Fed policy. We will learn more in the Feds minutes on Tuesday.

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