Although I certainly would not rank it alongside Macro Man's dreaded vacation indicator or the incipient increase in the USD, if and when the Economist finally decides to slot its decline on the front page, I still have the nagging feeling that whenever yours truly sits down at either a dull and difficult econometrics lecture or, as today, camps at school for a lab session in connection with a paper due next month, some event is bound to wreak havoc on markets while your author is busy estimating regressions. I would assume that some US market participants felt the same Thursday as they gave thanks before hauling in the turkey.
In any case, this time around the skeleton that could be kept in the closet no longer is neither Baltic nor Spanish; it is Middle Eastern. At this point, I am of course simply trying to get an overview like the rest of you and not least deciding whether it will have any far reaching repercussions beyond Thursday's theatricals. However, in case you did not turn on your Blackberry Thursday, the story is that the Dubai government has requested investors in the debt of the investment company Dubai World whether they wouldn't be so nice as to accept a wee postponement of the payment of their debt. Especially, a payment due already the 14th of December in the form of $3.52 billion of bonds from property unit Nakheel PJSC looks as if it is near dead in the water.
The price of Nakheel’s bonds fell to 70.5 cents on the dollar from 84 yesterday and 110.5 a week ago, according to Citigroup Inc. prices on Bloomberg.“Nakheel is now standing on the brink of failure given the astonishing amount of cash Dubai would have to inject on it in order to see the enterprise survive,” said Luis Costa, emerging-market debt strategist at Commerzbank AG in London.
Obviously, announcements of delay of debt payments smells an awful lot like default and with $59 billion worth of liabilities at Dubai World many a financial institution and investor are exposed here. Naturally, and apart from the internal mess this is likely to cause in the Middle Eastern region, I am looking closely at the notion of European banks being sucked in here too.
The biggest creditors are Abu Dhabi Commercial Bank and Emirate NBD PJSC. Other lenders include Credit Suisse Group AG (CS), HSBC Holdings Plc (HBC), Barclays, Lloyds Banking Group Plc (LYG) and Royal Bank of Scotland Group Plc (RBS), according to a person familiar with the situation. Barclays slumped as much as 6.9 percent, the biggest intraday loss in a month, while RBS sank as much as 8.3 percent. Lloyds and Credit Suisse dropped more than 3 percent.
As ever, it will be most interesting to see which adventures European (and indeed US) financial institutions have been engaged in with the cranes of Dubai and thus how much more junk they will now have on their balance sheet (question: does the ECB by chance have collateral from Dubai World in the tank?).
Naturally, this may all get a happy ending for the creditors if a) the Dubai government decides to foot the bill through a massive liquidity injection and b) it does not default in the process. Since the government itself, it appears, took part in suggesting the repay delay/restructuring, the stakes were raised already from the get go. Especially as both Moody's (MCO) and S&P have indicated, initially through massive cuts of companies and funds in the region, that they might consider the move to ask investors for a delay in repayment as a de facto default - a statement which together with the state of play naturally have seen credit default swaps soar for both sovereigns and companies across the region.
Globally, the reaction was equally strong, with stocks across the board taking a hit and yields on developed economy government bonds dropping to reflect the knee-jerk move into "safety" assets by part of global investors. In this respect, I agree with the underlying sentiment expressed by Russell Jones from RBC Capital markets
"Dubai isn’t doing risk appetite any favors at all and the markets remain in a vulnerable state of mind,” said Russell Jones, head of fixed-income and currency research in London at RBC Capital Markets. “We’re still in an environment where we’re vulnerable to financial shocks of any sort and this is one of those."
The key here is exactly whether this merely reflects the fact that markets and risky assets are naturally nervous and thus how it takes only a small (or large?) disruption for risk aversion to decline or whether there is a stronger and more structural theme at play here with respect to the potential real contagion the events in Dubai might have. At this point I am leaning towards the former simply because I have no reason or knowledge to claim the latter. I suspect that minds more informed than mine will let us know soon enough as well as any untold stories that will surface sooner rather than later.
More importantly (at least for me), it was interesting to see that old habits still linger in the context of FX markets;
The yen climbed as high as 86.30 per dollar, the strongest since July 1995, before trading at 86.60. The U.S. currency strengthened against all but the yen among its 16 most-traded counterparts, appreciating 2.6 percent versus the New Zealand dollar and advancing 2.4 percent against the South African rand.
The Swiss franc weakened as much as 0.3 percent per euro, falling from the highest level since June, on speculation the Swiss National Bank sold the currency to curb its gains. The franc dropped 0.9 percent to 1.0057 against the dollar after yesterday reaching parity for the first time in 19 months. The SNB declined to comment.
Now, whether this is a story of unwinding of carry trades and low yielders reacting to risk aversion as I have tended to interpret it (a position which Cassandra, by the way, recently called disingenuous at best and ludicrous absurd puerile) or simply, as would be Cassandra's point, systemic deleveraging and thus a retrenchment of funding liquidity (primarily in USD) is an open question which I intend to deal with in more detail in the future. For now, it will suffice to say that the USD acts as a carry trade funder alongside the JPY, with the Swissie apparently still supported by the bullying of the SNB. In short, if it walks like one and quacks like one ... well.
For more background on Thursday's Dubai Delights we can thank the job rotation schedule at FT Alphaville for having Izabella Kaminska at the rudder (among others) as she was relentless in digging up background and information on the situation in Dubai throughout the day. Over and above the tragicomic allure of the failed conference call scheduled for bond holders of Nakheel (a guy called Murphy springs to mind), I take notice of the "sterling connection" and specifically the idea that the Pound may suffer from the Dubai rout as the sheiks and the rest of their ilk will be forced to sell UK real estate assets (time to buy a Chelsea penthouse then?) in order to kick up the funding needed. Here is Izabella;
In other words, if default is really on the cards, chances are Dubai World will have to start a major fire-sale of assets. Unluckily for the UK, the Middle East and the UAE have for a very long time viewed the British real-estate market as a safe-haven investment.
Whether the inflows from the window shopping of super affluent Middle Eastern investors in the UK real estate market have been a marked driver of the exchange rate is debatable, but Izabella digs up some comments by BNP Paribas (OTCQX:BNPQY) who certainly seems to think that this is the case. So we better watch that one too then. Finally, Izabella head-butts Barclays Capital by juxtaposing an old note dated only this month in which BC recommends a long position in everything debt related to Dubai (Sovereign as well as Corporate) with a more current note in which this argument is, um, relaxed. A cheap shot you might argue - perhaps, but fun and interesting nonetheless.
Dubai Delights No More?
I have to say that it was not without a bit of the old Schadenfreude that I loaded up Bloomberg and Reuters Thursday afternoon to learn that Dubai seems to be facing a great unravelling. We still need to get the full story of course at this point, and if the Dubai authorities step up, it may all turn out to be a storm in a tea cup. However, on a personal note, the "Cranes of Dubai" always represented one of the clearest examples of the excess and froth observed in the context of the economic boom that ended abruptly with the current financial crisis. With this in mind I am not the least surprised about this which of course is easy to state ex post, but then you can choose whether to believe me or not.
More generally, it need not, naturally, put an end to financial and economic development in the region, but it is one thing to have and collect commodity windfall and quite another to spend it wisely and productively. One would hope that this serves as a timely reminder as we move on from here.