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Too Big to Fail: Reasons to be Fearful 12/01/2010

Posted by chrisdshaw in Economics, Financial Crisis.
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As investment banks announce record bonus pools for 2010 while economic growth expectations for the developed world remain sluggish, media attention has been directed once again towards the widening disparity between Wall Street and Main Street. Away from the non-financial press focus with bonuses, there appears to be a growing anxiety about the level of risk taken on by the largest institutions. Karl Whelan highlights the concerns, most notably by former IMF Chief Economist Simon Johnson.

Sterling has most to lose from Dubai 30/11/2009

Posted by chrisdshaw in Economics, Financial Crisis, FX.
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Following the flight to safety and sell off in the risk assets on Thursday and Friday of last week, markets today showed a return to stability with equity markets closing up in Asia and marginally down in Europe. Abu Dhabi and Dubai, whose markets opened today for the first time since the news of Dubai World’s warning on debt repayment, witnessed a record drop in their indices; falling 8.3% and 7.3% respectively. Fears that the delay in debt repayments by Dubai World may signal new strain of systemic risk have largely abated. The United Arab Emirates central bank’s announcement that it would stand behind domestic and foreign banks has reassured investors and has stemmed a potentially larger capital flight. Nevertheless, the news from Dubai is a sharp reminder that the financial crisis that began two years ago and almost destroyed the global economy a year ago is still with us. Pimco’s Mohamed El-Erian believes Dubai is a reminder that we still need to deal with the repercussions of massive credit expansion to unjustifiable projects earlier this decade.

Despite the emirate’s astonishing level of self-aggrandisement, Dubai’s debt is not enough to rock financial world. Of the $123bn of UAE foreign obligations, US banks account for $10.6bn, Japanese banks for $9bn and EU banks $40bn. The UK appears to be uniquely vulnerable to a potential Dubai default as British banks account for $50bn of the debt. The Foreign Exchange markets have reflected this, with Sterling being the only currency to fall against the USD at the start of the trading week. The US Dollar had strengthened significantly against all currencies, bar the CHF and JPY. The resumption of a weakness reflects a modest return to risk. However, the news from Dubai has had a broader impact on sentiment towards sovereign debt. Given the sharp increase in debt to GDP over the last two years, no end in sight for emergency monetary policy and, unlike Euro area countries such as Greece and Ireland, an ability to put off difficult political decisions by devaluation, Sterling may be the biggest loser from the Dubai debacle.

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

Posted by chrisdshaw in Financial Crisis, FX.
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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.