The full brunt of U.S. traders are back in their offices and judging from the price action in the currency and equity markets, they are not entirely convinced that Dubai's problems will end up troubling the world. Yes, Dubai is a major global player but the British have much more to worry about than the Americans. Of the UAE's total cross border banking exposure, European banks hold 72 percent and 41 percent of that is with the U.K. U.S. and Japanese exposure only amounts to 9 and 7 percent of the total flow. This explains why the British pound is the only high beta currency that is not rising against the U.S. dollar this morning. For the most part, it appears that currency and equity traders have shrugged off the news. Although we believe that an all out default of Dubai's sovereign debt is not an immediate risk and the situation is not nearly as grave as some people make it out to be, it is still unfolding. Fundamentals still support further dollar weakness but we caution traders against taking large positions.
Risk appetite is also benefiting from positive U.S. economic data. Chicago PMI rose to 56.1 from 54.2, the highest level since August 2008. Earlier this month, there was a bit of confusion about how the U.S. manufacturing sector is performing. Conditions deteriorated in the NY region but improved in Philadelphia. We now know that the sector continues to expand in the Chicago region which suggests that the national ISM manufacturing index may have also risen in the month of November. All but one of the underlying components (production) increased, with the employment component of Chicago PMI rising from 38.3 to 41.9.
Canada: Low Inflation and Strong Growth
Aside from the Chicago PMI report, one of the more important economic releases this morning were Canada's GDP and inflation reports. The Canadian economy grew 0.4 percent in the third quarter with a similar degree of growth in September. The Q2 data was also revised higher from an annualized rate of -3.4 to -3.2 percent. In other words, Canada, like many other countries around the world came out of recession in the third quarter. The latest industrial product and raw material price figures were mixed with the former falling 0.3 percent and the latter rising 2.5 percent. Relatively low inflation levels and positive growth reflects the improvements in the Canadian economy. However the Canadian dollar has struggled to rise since growth in Q3 fell short of the market's 1.0 percent forecast. There are no additional reports from Canada until Friday, when employment numbers and IVEY PMI are due for release.
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The rift between Japans MoF and BoJ we mentioned in Friday's article is resurfacing as the finance ministry pressures the central bank on further easing monetary policy. The yen lost ground in early EU trading after Japan's strategy minister Kan says govt agrees on measures to stop the yen rise. But As European stocks extend into negative territory and FTSE-100 drops 50 pts, yen strength resurfaces across the board. USDJPY 4-hr stochastics suggest downside to call up 85.70, while 87.00 still acts as robust resistance. AUDJPY capped at 91.30, and is vulnerable to further losses towards 78.20.
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Last week while US traders prepared to sit down to a peaceful Thanksgiving meal, the currency market became embroiled in the Dubai debacle sending risk FX tumbling from its year to date highs. With weekend news suggesting that Abu Dhabi may step in to help out with some if not all of the Dubai World debt problem, risk assets have rallied with EUR/USD once again trading above the 1.5000 level.
However, although the turmoil I the Middle East markets appears to have been contained for the time being, the story is unlikely to go away just yet. Many market observers have correctly pointed out that the scope of the Dubai World problem is miniscule in the greater scheme of things with liabilities in question equivalent to only 5 basis points of total US and European bank assets . Yet it is not the absolute value of the loss that is in question here but rather the psychological impact of the a possible default. Such a move could result in a rapid contraction of risk appetite across all capital markets which in turn could threaten the nascent global economic recovery.
Last week, economic data throughout the G-10 universe was generally positive beating market expectations and provided support for the risk rally that saw most of the high beta FX reach yearly highs against the dollar just before the holiday. The unexpected news from Dubai quickly unwound those trades and now the central theme this week in FX is likely to revolve around this tension between the recovery bulls anticipating yet further improvement in the economic data and the bears who are betting on resumption of credit crunch fears that will suppress any rebound in activity.
With the risk trade having rallied so strongly over the past six months, any disappointment in this week’s economic data starting with German Sales and Unemployment report tomorrow and ending with the US Non- Farm payroll number on Friday, could trigger a significant round of profit taking as investors and speculators try to lock in returns for the year. Although seasonal factors favor a further rally in the euro both on the end of the month and end of the year basis, this year the pattern may be different. With the risk trade having been essentially a one way bet since the bottom set in March, a correction is due. If the eco data this week misses to the downside, it could provide the catalyst for a further unwind in high beta FX.
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British banks are Europe’s biggest lenders to the United Arab Emirates, constituting $49.5 billion of the continent’s $87.3 billion loans outstanding to the Gulf state, Royal Bank of Scotland Group Plc said.
French banks have the second-largest amount of loans, $11.3 billion, followed by $10.2 billion for Germany’s banks and 4.7 billion for Dutch lenders, RBS said in a note today, saying it used Bank for International Settlements data.
The figures are for loans as of June 2009 and exclude bonds, the note said. Separate data for Dubai, one of seven emirates that make up the U.A.E., are not available, it added.
Stocks and commodities dropped today, Treasuries jumped and credit default swaps climbed after Dubai’s attempt to reschedule debt rattled investors this week.
The British government has given more than a trillion pounds ($1.67 trillion) of publicly funded support to keep the U.K. financial system afloat since the beginning of the worst post-Depression financial crisis last year. RBS is getting 45 billion pounds ($75 billion) from the British taxpayer, making it the world’s most expensive bank bailout.
Swiss bank loans to the U.A.E. stood at $4.3 billion while Italian banks had $1.9 billion and Belgian lenders $1.3 billion in loans outstanding, RBS wrote. The figures for the U.S. and Japan are $9.9 billion and $8.6 billion, respectively
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The central bank of the United Arab Emirates said it would provide a special fund to back local and international banks operating in the UAE, media reports said.
The UAE central bank said it stands behind those lenders, the reports say.
The central bank, based in the emirate of Abu Dhabi, said it had told the banks that it had set up a special liquidity facility at a rate of 0.5 percentage point above the Emirates interbank offered rate, media reports said.
Dubai World, the conglomerate controlled by the government of the neighboring emirate Dubai, has asked for a six-month standstill on repaying its debt, estimated at almost $60 billion.
Meantime, U.K. media reports on Sunday quoted a senior Abu Dhabi official, who wasn't identified, as saying that the emirate will assess carefully whether and how to assist Dubai.
The official was quoted as saying that it would approach Dubai's commitments case by case and would not necessarily underwrite all its debts.
The Times of London reported that investment bankers advising Dubai expect the emirate to sell high-profile assets, like the QE2 cruise liner and the Turnberry golf course.
The Telegraph quoted sources close to Dubai's government as saying that the western financial-services bailouts might provide a model for the emirate. The paper said advisers have suggested that the problem debts - particularly those of Dubai World's Nakheel real-estate unit - be ring-fenced, or sequestered from the good assets
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WTI crude oil price plummeted to as low as 72.39 after Dubai's attempt to delay its debt repayments. Investors turned cautious as the news raised concerns on global economic recovery and hence improvement in energy demands. However, the black gold, as well as other risky assets, rebounded strongly and closed almost flat from Thursday. Over the week, the benchmark contract for crude oil slid -1.8% to settle at 76.05.
Although crude oil continued to move within the recently established range of 75-80, its trading momentum has clearly shown fatigue. Moreover, price movement has derailed from weakness in USD. We believe this has been driven by the sluggish fundamental outlook on the energy market.
Released by the US Energy Department, crude oil inventory rose +1.02 mmb to 337.8 mmb in the week ended November 20 as driven by builds at the Gulf Coast. Imports bounced back as operations resumed after Hurricane Ida. Builds in the Midwest was mainly driven by Cushing inventory while surged +1.2 mmb to 29.5 mmb.
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Sri Lanka purchased 10 metric tons of the IMF's planned gold sales. According to the central bank's announcement released last Thursday, it has been acquiring Gold from the international market over the past several months 'as a part of the diversification of the external assets portfolio'. The central bank believes the long-term stability of Sri Lanka's external reserves will be strengthened as gold holdings will provide 'a stable and long-term cushion against the impact of any potential volatility in major international currencies and financial instruments, in international financial markets'.
Sri Lanka was the third central bank in the world, as well as in Asia, to buy gold from the IMF this month. Earlier, the Reserve Bank of India and central bank of Mauritius purchased 200 metric tons and 2 metric tons, respectively, from the world lender.
Sale to Sri Lanka was announced shortly after Financial Chronicle's report that India may want to buy the remaining of the IMF's planned gold sales. This reinforced the notion that central bankers are seeking to diversify their reserves and gold is believed to be a good choice.
Apart from Asian economies, emerging markets such as Russia is also accumulating gold. Earlier this week, Bank Rossii, Russia's central bank, reported that it increased its gold holdings by +2.6% to 19.5 metric tons in October so as to raise precious metals' percentage in reserves.
According to Chairman Sergei Ignatiev, 'the central bank has in the course of several years replenished its supply of gold with the goal of diversifying our gold and foreign currency reserves'.
Bank Rossii First Deputy Chairman Alexei Ulyukayev said on November 18 that the central bank is ready to buy all gold (30 metric tons) that Gokhran, the precious metals stockpile in Russia, has planned to sell this year.
The events in Dubai have once again brought attentions to sovereign risk and this should drive investors to safe-haven assets. The sharp rebound in USD and selloffs of risky assets such as equities, emerging market assets, commodities and high-yield currencies were an indication of risk aversion. While investors may worry that strength in the USD will pressure gold, the yellow metal did outperform during times of sovereign crisis, even though the dollar strengthened,
EURUSD peaked in mid-July, 2008, as investors found out that the US was not the only economy that was facing financial crisis. In fact, the disaster was contagious and economies worldwide also suffered. USD began to rise against the euro. At that time, inflationary pressure was subdued due to recessionary fear and slumps in commodity prices. Interestingly, gold price surged against the backdrop. We believe the temporary breakdown of the gold's inverse correlation with the USD was mainly due to fear that the global financial system might fall.
While we believe the contagious effect of Dubai's bankruptcy to other emerging economies is not big, market sentiment is always the most important driving forces for asset prices. Therefore, should investors' concerns on the issue aggravate and risk appetite tumbles, there's chance for gold and USD to rally at the same time.
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News that a property development arm of Dubai World requested to delay its payments triggered sharp volatility across the financial markets. The story actually broke on the eve of November 25th and on the 26th , currency traders began to flock into the safety of U.S. dollars. The demand for dollars was so strong that the euro hit an intraday low of 1.4829 when the European markets opened. The price action in USD/JPY tells us that risk aversion was the primary driver of the forex markets as USD/JPY fell to a 14 year low when the Asian markets opened last night. However the selling did not continue into the U.S. trading session. The limited number of U.S. traders at work today sold rather than bought dollars which suggests that not everyone believes that the Dubai news will have global ramifications. Whether this is true or not remains to be seen but whenever there is a situation where traders are unsure about how the political or economic environment will pan out, such as Dubai's woes, they always sell first and ask questions later. As a result, the USD and JPY were the biggest beneficiaries.
Understanding Dubai’s Problems
A major exogenous risk like the Dubai news is one of the few things that can trigger a bottom in the U.S. dollar as the greenback's safe haven status overrides U.S. fundamentals. On the eve of November 25th, the Thanksgiving Holiday in the U.S. and the Eid Holiday in the Middle East, Dubai World shocked the markets by saying that its property developer Nakheel has requested to delay its Dec 14 debt payments. Dubai World is not technically owned by the Dubai government, but with liabilities of US$59 billion, it is a significant amount of the total estimated US$80-100 billion in Dubai's liabilities. As a result, investors fear that this could mean an outright default on Nakheel's debt as delinquency is usually the precursor default. Although the market has clearly not taken this news well and believes that it is a major development for the global economy, it is important to realize that Nakheel's debt is only $3.52 billion, a fraction of Dubai World's overall debt. Also, U.S. and European banks have very small exposure to Nakheel’s debt. Granted a default may entitle investors to some of Dubai World's assets, H.H Sheikh Ahmed bin Saeed Al-Maktoum, Chairman of the Supreme Fiscal Committee, has already issued a statement confirming the Dubai Government's intention to directly intervene and manage the restructuring of Dubai World commercial operations and its debt obligations. Although some people are afraid that this could turn into an Argentina style debt default or a repeat of volatility of Q4 2008, what is more worrisome is the fact that this may be indicative of the health of the entire property sector in the Middle East.
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16395 is a key level on the Daily Chart. Subject to close we are forming a pin bar today. The tail bouncing off a lower resistance level. While there are plenty if other levels to look at on other timeframes, with the Weekly pointing down, this level will give us a clue for next week.
