Bond Futures

Overview

In the light of the negative news out of Dubai and continuing sentiment the Bund has rallied significantly over the last five days. On Friday when the panic surrounding Dubai peaked, the bund hit highs of 124.06, a price not seen since April 2^nd. The US Ten Year mimicked the action of the Bund; highs of 121.215 represented a price not seen since mid May.

Thoughts from the trading floor

Last week the Bund broke some very important daily resistance levels; firstly the previous daily double top at 123.12 before taking out and closing above a daily level at 123.47. After such a strong run up in the last few days, if the Bund holds onto ground above 123.12 we would argue it remains bullish, a failure would signal a false break and could result in a strong reversal. The US Ten Year continued to outperform the Bund as it broke the daily double top level and accelerated almost another 2 points. In doing this it broke support at 120.165 and 121.110. Like the Bund it needs to hold above these resistance turned support levels to remain bullish.

On the back of the Dubai debt concerns last week and the news yesterday that the Dubai Government will not guarantee Dubai World’s debt (thought to be somewhere around the $26 billion mark) the question is what are the tail risks for the wider economy? The problem that Dubai World may face is not that different from what the banks have recently “dealt with”. If they need to sell or shift assets they will have to set a price and due to their assets illiquid nature in the current climate (mainly real estate) this price will be very low. At the moment the markets appear satisfied that the recent restructuring of debt will suffice, but if this proves inadequate a fire sale scenario may follow which would have far reaching consequences.

Since mid November we have seen the yield curve in Germany flatten. We believe that this trend will continue as the world macro picture deteriorates. Assuming the Dubai situation acts as a catalyst for an unwinding of risk trades we could see this trend accelerate as inflation risks deteriorate and fears of a Japan situation increase.

Bull View

Bulls will be keen for the Bund to consolidate above the broken level which was previously the daily double top (123.12). A continuation of concerns surrounding Dubai or a bad jobs report on Friday could push the Bund back towards recent highs.

Bear View

Bears will be desperate for both the Bund and US Ten Year to recapture ground below recently broken resistance. If this is achieved the recent fast rise in bond prices may begin to look like an exhaustion rally and we may see a decent pull back.

Futex View

We believe that the recent run up in Bund and US Ten Year prices is sustainable but before any more significant gains are achieved we may see some consolidation and a retest of broken resistance.

Equity Index

Overview

Last week should have been relatively quiet due to the US Thanksgiving holiday but thanks to the concerns surrounding Dubai this proved not to be the case. After significant losses were seen in Europe on Thursday as the news broke, the return of US players on Friday restored order and US and European markets stabilised.

Thoughts from the trading floor

In the early parts of last week the S&P 500 future fell just short of recent highs as it recaptured all of last weeks losses. The fundamental news out of Dubai on Thursday caused the market to push down and test daily support at 1082.75, closing the day just shy of this level at 1083.00. On Friday morning the S&P future followed the European markets lower breaking 1083.00 before rallying back above here after US cash open finishing flat on the day. The result of these moves has been the formation of a tight daily double top in the S&P 500 future at 1112.75, the target of this formation is 1055.00. The European equity indices looked to have formed a daily head and shoulders formation with a neckline in the Eurostoxx 50 future at 2634. This formation is not technically perfect owing to the steepness of the neckline, it is worth considering however as if it catches the markets attention it could lead to a significant down move.

Over the last few months we have said that we believe a significant equity pullback will occur but it will need a shock development to trigger it. The question that has to be answered now is whether the Dubai debt uncertainty is that shock? There is no doubt that it will act to remind investors that we are not clear of the credit crunch fallout but the level of contagion and wider fallout will determine how important this event will end up being. What is certain is that this new development will have stirred some of the bears and it is likely that we will see a reduction of risk trades over the next few weeks.

Dubai aside, this week should prove important anyway as we see the last significant jobs data of the year. Wednesday sees the release of the ADP jobs survey, possibly the best indicator of the Non-farms number; and on Friday we get the real thing. Current expectations for Non-farm payrolls lie at -118K, the highest average analyst’s estimate for over 12 months. Alongside the headline number it will be worth keeping an eye on the Unemployment rate, last month this shocked markets as it spiked to the upside. Analysts are expecting to see no change this month so a further move to the upside could get a lot of attention.

Bull View

Bulls will be keen for the Dubai problem to be sorted and for jobs data to support there position allowing the bearish technical formations to be discounted.

Bear View

Bears will feel that Dubai is a turning point and that we are currently seeing a reversal formation develop. The more far reaching the fallout proves to be more likely they will be proven correct.

Futex View

We believe that Dubai is the beginning of a reversal in fortunes for the bears and the next month will contain the top of the rally. A disappointing jobs report in the light of the Dubai wobble could prove critical short term bulls.

Macro- Overview

Focus on Dubai

The last two days has seen news that Dubai World (the investment company owned by the state of Dubai) asked its creditors for a freeze on the repayment of debt. This effectively has raised concerns of a potential state default. Global risk trades have taken a battering with equities, commodities and high yielding carry trades have taken significant hits.

Thoughts from the trading floor

The main unit within Dubai World’s portfolio, Nakheel PJSC has debt repayments of around $3.52 Billion due on 14^th December and the company looks “dead in the water”. The failure of Dubai State to be able to meet these obligations is quite a clear indication that the State may be heading for bankruptcy. The last decade had seen amazing infrastructure growth in Dubai, fuelled by cheap credit availability and Sheikh Maktuom’s desire to build Dubai into a global commercial centre. Dubai and its decadence had become a reflection of the world of finance of this time. The global credit crunch and the collapse in real estate prices has hit Dubai particularly severely, due to its dependence on real estate and cheap credit.

The question now, which is hurting risk appetite the most, is who is exposed to the most? Key UK banks such as HSBC, RBS, Standard Charter, and Lloyds Group are touted to have significant exposure (the British considered Dubai to be a real estate safe-haven). Most likely many banks globally are caught with exposure, despite many denials (as they did during the subprime crises). Therefore, as with the subprime mortgage crises, the contagion effect is more important the direct material exposure to Dubai World. As we have seen in the recent 2 years big credit events will affect banks that may not have superficial exposure to the main problem. If the Dubai contagion does spread, causing a credit default event across the whole Gulf peninsula and banks have to write down real estate asset prices, the “price discovery” of these assets has the potential to cause significant write downs of real estate assets globally. This has been something that banks have been attempting to avoid of late, the discovery of true value of Commercial Real estate. Also, we must consider that many banks have been using CRE securities as collateral to borrow from the Fed and the ECB. This could mean that these central banks are sitting on a time-bomb of poor assets. With the US, in particular, struggling with its fiscal deficit, can it afford to have more holes blown into its balance sheet?

Bull View

The bulls hope that this event passes quickly, and the fall in global risk assets has just been accentuated by thin volumes. They will hope that the situation can be resolved through a bailout by Abu Dhabi and possibly the Saudis. With respect to this, a steep fall in global risk assets may provide the perfect buying opportunity for a year end rally.

Bear View

The bears will see this as the start of a new “perfect storm”. Global financial institutions are still reeling from the 2008/09 bear market, and have significant exposure to poor quality securitised debt. The risk lies in this event sparking the start of a new downward leg for global risk. With governments around the globe crippled with debt, help may not be available this time round.

Futex View

We favour the bears currently. For weeks we have been wary of the rally in global risk and the over optimism shown by markets. The fact is that the last decade of debt “binge” will continue to weigh on the global economy as the imbalances that have been built up over this time have not corrected themselves. Instead these imbalances, such as the debt owed by developed countries have increased. This event may not be the final “nail in the coffin” for global finance; however we are getting close to “sealing the coffin”.