Brave New World

The correction we have all been waiting for? 26/11/2009

So much for a quiet Thanksgiving weekend. Last nights news that government owned Dubai World’s had requested an extension in repayment of its debt until May of next year has sent shock waves around markets in the last 24 hours, with European equity markets falling by an average of 3%- the most in seven months. European banks, who are heavily exposed to Dubai, were the biggest losers of the day with shares in British banks such as HSBC and Barclays falling more than 5%. Credit default swaps have jumped not only in Dubai but also other countries with precarious fiscal positions- Ireland and Greece being notable examples in the EU. By contrast, yields on government bonds from safe haven currencies have dropped. The knock on effect has led to a sell off in markets around the world. The Shanghai Composite Index slumped 3.6% and the Brazilian Bovespa fell 2%.

The currency markets have experienced a sharp pick up in volatility over the last thirty six hours, with significant levels being breached in a number of currency pairs. With risk appetite being pared back from the Dubai news, the USD has to some extent benefitted from its safe haven status. EURUSD is back below the 1.5000 level, and GBPUSD and AUDUSD have fallen two hundred pips in the last 24 hours. The main winners in the FX market, however, have been the Japanese Yen and the Swiss Franc. USDJPY has broken through the 87 level, reaching the lowest level in 14 years. The US Dollar’s replacement of the Yen as a funding currency has been confirmed by the movement in the pair in this volatile but bearish environment. USDCHF dropped below parity, reaching a low of 0.9918. This followed comments from Swiss National Bank President Jean-Pierre Roth indicating that central banks would soon withdraw unconventional measures as the global economy gathers pace- a very different message from that given by the Fed earlier in the week.

The announcement was made on the eve of the 4 day Eid holiday in the Emirate. The overall lack of liquidity in global markets has undoubtedly helped create a volatile trading environment. The test will come tomorrow as US markets re-open. That will bring into focus whether we are at the beginning of a true risk asset correction, or whether the continued flood of liquidity will consign this to a minor hiccup in the Next Great Bubble.