Darshan's Blog

Darshan's Daily Market Ponderings

Dubai, Japan and Central Bank Madness.

Monday 30th November, 2009

Morning all!

Hope you had a great weekend? Been a pretty exciting weekend in the world of global finances - with the media continuing their Dubai tennis match. Will Abu Dhabi rescue Dubai? Won't it? Will it? Won't it? On and on it's been going on - despite the underlying story being the same - Yes it pretty much will. The only thing that has changed is the headlines...the actual copy has remained the same in each news article. Once again, you have got to love the press.

So what are the actual developments over the weekend? Well to begin with, Abu Dhabi has set up an emergency liquidity facility for all banks in the UAE - domestic or foreign. This should help in the short-term, while Dubai World's debts are rescheduled and restructured. Abu Dhabi has clearly sent a signal to say "We're doing this because we can, not because we have to" - by saying that it will "pick and choose" the best ways to help Dubai. Of course, it should be the other way around - Abu Dhabi is the capital of the UAE and can't be seen to just throw Dubai aside at a time like this - so it is not surprising to see spin being put on. So let's just put all this aside and get to the crux of the matter. This move means that the likelihood of Dubai defaulting is reduced and the 90 banks which the debt is spread over, will no doubt be feeling better.

Of course, the key concern is now the $3.5 billion Islamic bond associated with Dubai World's property arm, Nakheel, which matures on December 14th. That is the first problem that needs to be solved and Dubai's stock market closed the day almost 9% down over these concerns. This is not exactly unexpected though - especially considering that the market has been closed since the Wednesday announcement and so pressure would have built up. Despite this, such selling is a fools game - Islamic bonds are an important financing instrument for financing anything in the Islamic world - do you really think that any Arab Emirate is going to want to see the concept fail? Of course not. Sultan bin Nassel al-Suwaidi, the governer of the UAE Central Bank has immense personal wealth himself and this just adds to the peer pressure not to see an Emirate fail. However, despite this - the five year CDSs are still discounting a 44% probability of a sovereign default over the next five years - which is totally insane. There is enough money in the Sovereign wealth funds to cover everything, if it is absolutely necessary...but the rise in the CDSs shows how jittery the market still is - despite this huge rally since March.

All this will have a price, as predicted in Friday's note - the cost of the aid, will be firesales of Dubai's prized possessions such as the QE2 and possibly even the Emirates Airline. So there will be a lot of bargaining going on and I fully expect soundbites all week from the press. It will continue to be a "Deal is off the table" followed by "Deal is on the table" followed by "Deal is off the table" and so on. Each headline helping to make the markets even more nervous - just enough for there to be a nice dip to buy into for the Santa rally.

What we really should be focusing on is how the rescue package, deals with foreign creditors. Remember, UK banks are holding a lot of the counter-party risk on this debt. This is what we need to pay attention to and see what the deal offers them. I am not going to second guess the terms but I have a feeling that it will be domestic banks first, foreign creditors second - which could spook the markets more - as it means this could happen anywhere else in the world too. And so the madness continues.

On that note - Japan. The phenomenal strength in the Yen is causing serious problems with Japanese exporters and especially since the USD/YEN hit the 85 level last week - a level not seen since 1995! There is clearly no need for the Yen strength on the basis of the Japanese economy itself. The CPI is down by 2.5% year on year and the country is still suffering from the deflationary pressures lingering from the 1990s. Of course, this is what happens to a currency, when the FED plays around with the fate of the dollar so much and the Japanese Finance Minister Fujii is being very vocal about it. There is definite pressure for some sort of intervention but the question will be how? It seems the world's Central Banks have lost the plot and are unable to carry on their policies without affecting another currency in turn. It also seems that Japan maybe considering Quantitative Easing...the very policy that worked so well for it almost two decades ago now (Severe sarcasm alert). This is not set in stone but it seems the option is on the table. If it were to happen, not only would be see the dollar carry traders panic and revert back to the Yen, but it would be a very strange route of action for Japan - especially since they are already suffering from the last time they tried this. A better policy would be to wait this out, because the USDX is forming a bottom and it will reach breaking point through market forces - currency imbalances will resolve themselves. Japan even considering this option, is going to add a whole heap of confusion to the market. One that could make things very interesting and volatile. Of course the irony is that it's the low interest rates and loose monetary policy that have lead to problems like Dubai but we never will learn.

As ever, I await to see the next move in the wonderful world of global money. For today, let's focus on the markets. The Chicago PMI just came out higher than expected and it seems the market has just ignored it. Surprise surprise. It still feels like we are building a base for a move up this week, so I am reluctant to short this market. We could indeed see that 10050 level on the Dow by midweek, if the patterns from the last few months play out in the price or we could bounce off 10200 and begin our journey to new highs (As always, to mark the end of this miraculous bear market rally). The danger for an all out end to the great rally of 2009, will be an end of Central Bank liquidity pumps in 2010 - the FED has already talked about a reduction in QE by March 2010 and I am positive, the UK will have to follow suit. They have all tested their limits and now it's time to see if the markets can run on their own two feet. Personally, there is more chance of Gordon Brown winning the next election, then there is of that happening.

So for today, I wish you good luck and happy trading....stay nimble. If you have any questions, just shout.

Darshan

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