As I’m sure everyone is aware of by now, equity markets fell sharply around the world on Thanksgiving Day due to an announcement by the country of Dubai with regard to its debt. One of the fears hanging over equity markets in light of worldwide efforts to stimulate the economy through easy monetary policy is a default by one country on its debt that could then spread around the world, cause investors to seek shelter once again and spark another round of the credit crisis that began in 2008. Late Wednesday, Dubai announced that it was seeking time to pay its roughly $80 billion in debt. The announcement immediately sent the price of insurance on its debt (credit default swaps) spiraling higher, which, in turn, created fears that all country credit default swaps would become more expensive, thus pressuring debt-laden countries.
First, we should examine exactly what Dubai announced. The Economist provides some answers:
ONE of the biggest events in the Muslim calendar, Eid al-Adha, which begins this weekend, is supposed to be a festival of sacrifice. On November 25th investors in Dubai were given an early chance to get into the spirit of things. The emirate’s government asked creditors of Dubai World, one of three big government-backed conglomerates, to agree to a standstill on repayments until May 30th 2010 at the earliest. The standstill does not apply to Dubai Ports World, which operates one of the biggest container terminals in the world. But it does include the $4.05 billion due on December 14th to holders of an Islamic bond, or sukuk, issued by Nakheel, a developer responsible for the Palm Islands and other spectacular land-reclamation projects.
The announcement left investors feeling wronged and wrong-footed. Only weeks ago, Sheikh Mohammed bin Rashid al-Maktoum, Dubai’s ruler, assured investors that the emirate would soon raise the funds to meet “current and future obligations”. Either he was not ready to reveal what was afoot, or he did not know. In an autocratic regime like Dubai, bad news acquires an extra coating of sugar with each step it takes up the hierarchy.
There is one distinction that needs to be made and is not yet clear. A default occurs when the debtor tells the creditor it cannot meet its obligation. However, asking for a payment extension is not a default. So, there is some uncertainty as to exactly what has occurred or what is going to occur. Clearly though, Dubai is in some sort of trouble, and its investors will feel the pain. The key for the financial system is far that pain will spread and whether it will have additional consequences.
Please click on the following link to view the full article at The Economist: Standing still but still standing
Equity markets everywhere tanked on the news while U.S. markets were closed for the Thanksgiving holiday. Here is a look at the damage:
In Asia, Japan’s Nikkei stock average slid 3.2 percent, Hong Kong’s Hang Seng index tumbled 4.8 percent, and South Korea’s benchmark dropped 4.7 percent. In Europe, stocks fell on the worst trading day in several months on Thursday. But interestingly, European share recovered a bit today, and the U.S. markets, though down, did not finish as badly as the futures had indicated early on.
2:39 p.m. EST 11/27/09Major World Indexes(Roll over for charts)
1:24 p.m. EST 11/27/09Major Indexes(Roll over for charts)
[SOURCE: The Wall Street Journal]
What’s Next?
I believe that while this is a stark reminder of how fragile equity markets are and how interconnected the world is and that severe risks remain, this is not the onset of another crisis. Dubai’s debt problems had been documented previously – it just was not front-page news. But, even assuming this news took markets by surprise, the selloff has more to do with overbought conditions and a U.S. dollar that had fallen to some extreme lows. Thanks to Bespoke Investment Group LLC, we can see that prices on country credit default swaps have been declining throughout the year (except for Japan). However, even with these declines, prices are well-elevated from their pre-crisis levels at the beginning of 2008. It seems the risk of an event like Dubai had been assigned a fair amount of probability. So, again, the equity selling seems more like a move to ease overbought conditions, and Dubai was simply a catalyst. In fact, the S&P 500 bounced off its 50-day moving average (around 1070) before closing at 1091.49. That is not a sign of panic.
Here is the chart from Bespoke Investment Group LLC:
Below we highlight current credit default swap prices and the year-to-date change for the sovereign debt of 39 countries. As shown, default risk has declined for every country except Japan in 2009, including Dubai.
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Gregg D. Killoren
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Dubai Asks For Debt Payment Extension, Markets Tumble
As I’m sure everyone is aware of by now, equity markets fell sharply around the world on Thanksgiving Day due to an announcement by the country of Dubai with regard to its debt. One of the fears hanging over equity markets in light of worldwide efforts to stimulate the economy through easy monetary policy is a default by one country on its debt that could then spread around the world, cause investors to seek shelter once again and spark another round of the credit crisis that began in 2008. Late Wednesday, Dubai announced that it was seeking time to pay its roughly $80 billion in debt. The announcement immediately sent the price of insurance on its debt (credit default swaps) spiraling higher, which, in turn, created fears that all country credit default swaps would become more expensive, thus pressuring debt-laden countries.
First, we should examine exactly what Dubai announced. The Economist provides some answers:
There is one distinction that needs to be made and is not yet clear. A default occurs when the debtor tells the creditor it cannot meet its obligation. However, asking for a payment extension is not a default. So, there is some uncertainty as to exactly what has occurred or what is going to occur. Clearly though, Dubai is in some sort of trouble, and its investors will feel the pain. The key for the financial system is far that pain will spread and whether it will have additional consequences.
Please click on the following link to view the full article at The Economist: Standing still but still standing
Equity markets everywhere tanked on the news while U.S. markets were closed for the Thanksgiving holiday. Here is a look at the damage:
In Asia, Japan’s Nikkei stock average slid 3.2 percent, Hong Kong’s Hang Seng index tumbled 4.8 percent, and South Korea’s benchmark dropped 4.7 percent. In Europe, stocks fell on the worst trading day in several months on Thursday. But interestingly, European share recovered a bit today, and the U.S. markets, though down, did not finish as badly as the futures had indicated early on.
[SOURCE: The Wall Street Journal]
What’s Next?
I believe that while this is a stark reminder of how fragile equity markets are and how interconnected the world is and that severe risks remain, this is not the onset of another crisis. Dubai’s debt problems had been documented previously – it just was not front-page news. But, even assuming this news took markets by surprise, the selloff has more to do with overbought conditions and a U.S. dollar that had fallen to some extreme lows. Thanks to Bespoke Investment Group LLC, we can see that prices on country credit default swaps have been declining throughout the year (except for Japan). However, even with these declines, prices are well-elevated from their pre-crisis levels at the beginning of 2008. It seems the risk of an event like Dubai had been assigned a fair amount of probability. So, again, the equity selling seems more like a move to ease overbought conditions, and Dubai was simply a catalyst. In fact, the S&P 500 bounced off its 50-day moving average (around 1070) before closing at 1091.49. That is not a sign of panic.
Here is the chart from Bespoke Investment Group LLC:
Below we highlight current credit default swap prices and the year-to-date change for the sovereign debt of 39 countries. As shown, default risk has declined for every country except Japan in 2009, including Dubai.
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