NBF - National Bank of Fujairah

Newletter Issue 5th December 2011

05 December 2011

Overview

Another volatile week saw risk assets end the week much higher, with the SP up 7.4% on the week to close at 1244.

In a week which started with ongoing concern around the Euro zone crisis, the announcement of Central Bank Coordination on Wednesday afternoon turned everything on its head, with risk assets immediately rallying, with EUR/USD rising around 150 pips in a matter of minutes.

While most risk assets retraced some of the move up, Gold, interestingly, did not, leading to lots of talk in the market that this was the moment when Gold will finally decouple from risk assets and return to its more familiar self. This however, has not materialized, and we are still waiting (and expecting) this key moment.

US Non-Farm Payrolls numbers came in strong, with upward revisions for previous months helping to move the unemployment rate to 8.6%. Risk assets, however, sold off on Friday afternoon, with fears inEuropedominating the day.

In regional news, the Ministry of Transport here in the UAE announced the start of the initial groundwork for the Union Railway Project, which will run fromAbu DhabitoFujairah, via Jebel Ali. This has been keenly awaited, and will be the first railway of its kind in theMiddle East. Elsewhere in the UAE, the ministerial cabinet approved the new draft of the Companies Law, which will allow foreigners to fully own business in certain segments in the UAE.

Previously, one would need to operate out of a Free Zone, or have a local sponsor who would own 51% of the business. We are waiting to hear exactly.

Fridays Closing Levels

Euro Area

The week started on a nervous tone inEurope, with more and more problems arising. Italian yields were rising, with the 10y reaching a high of 7.36%. Trouble has reachedBelgiumand Austriatoo these days, and a couple of Belgian banks, including Dexia, were downgraded last week by various agencies. Nevertheless,Belgiumreceived a little respite following an announcement that a coalition government would finally be formed there.

We saw a very disappointing German Bund auction, with only 61% of the bunds being taken. While this comes behind a backdrop of extremely low yields, this was not the first disappointing auction inGermany, and one surely has to worry whenGermany, so far seen as an invincible force inEurope(and the only one!) cannot borrow fully from the markets.

European leaders continue to downplay any talk of a breakup of the EMU or anyone exiting it. While many attempts have now been made at solving the crisis, as I always say, sometimes there just is no easy solution, and we may see a lot more pain for investors to come.

EUR/USD is currently trading in a 1.3200 to 1.3550 range, and I favour selling it towards the highs of that range.

UK 

Sterlingcontinues to trade on news abroad, particularly inEurope. Last week was no change to this, as GBP/USD traded broadly with risk assets. Indeed, the greatest driver last week was the announcement that the Fed had reduced the cost of USD liquidity, providing relief for stressed and tense financial markets. GBP reacted in line with recent risk correlations, weakening against the EUR and commodity currencies, and strengthening against the USD. 

Japan

USD/JPY has been somewhat more volatile recently, and following the previous week's move high, USDJPY continued to rise in the week, until the central bank coordination announcement hit the screens, taking USD lower against all major pairs. Nevertheless, post the announcement, the JPY continued to drift lower, with USDJPY closing just below the 78.00 level on Friday.

US

On Wednesday morning, the Federal Reserve, along with the Bank of Canada, BoJ, ECB, BOE and SNB, issued a press release outlining new details and amendments to the Foreign Currency Liquidity Swap Lines between the six central banks. The lines have been extended through to February 2013 and the rate on operations has been decreased by 50bp to OIS+50bp. In addition, measures have been taken to provide liquidity in any of the central banks currencies, if necessary. The new rate is effective 5th December 2011. The ECB made a separate announcement that it will reduce the initial margin for 3m USD operations from 20% down to 12%. All this has significantly reduced borrowing rates.

This news followed steps taken by the EU towards easing bank funding stresses.

Front end Eurodollar contracts reacted positively to this news, with the front contract rallying around 15bp on the news (implying USD Libor 15bp lower than previously).

Data has been positive in theUSrecently, and the NFP number on Friday continued this trend, with payrolls rising 120k. While roughly in line with expectations, the number was certainly solid, as were the upward revisions to previous reports. Upward revisions for the previous two months totaled 72k, including 42k in the private sector. This, along with a shrinking of the labor force, led to a fall in the unemployment rate to 8.6%

As I always say, proceed with caution here. Certainly this is good news for the markets, but we need to see a continuation of this, and in bigger size, before we get too optimistic. And then we have the housing market, which continues to perform poorly.

We also have earnings season coming up in theUS, and early signals are not comforting. Companies cutting forecasts outpace those raising estimates by the greatest ratio in 10 years, with some sectors, such as materials, looking particularly weak. While forecasts are just that, it is a reminder that despite improving data, there is a long way to go before this crisis is finally behind us, and with the euro zone crisis ongoing, and fears around slowing growth inChina, a return to normality may be a long way away. In my view, we will not be going back to normality as most people know it all. I do hope I am wrong, but I believe the world will have to accept lower growth in the future, and we may have something similar toJapan's lost decade, but this time worldwide!

  The Week Ahead

German Chancellor Merkel and French President Sarkozy are meeting inBerlintoday, attempting to find a common position to shape the debate in the upcoming EU leaders' summit, which takes place on Thursday and Friday.

With central banks dominating the news last week, they have another key week ahead, with a host of key interest rate decisions coming up.

On Tuesday the RBA will announce its cash rate target, with market consensus being a 25bp cut, following a cut in November. On Wednesday we then getCanada, another commodity country, whose main trading partner is theUS. Despite recent improvements in US economic indicators, the international outlook means that BoC should remain cautious, and leave rates unchanged at 1.00%.

On Thursday, we get Bank of England and European Central Bank Decisions. The BoE November Inflation Report has made things interesting. A 50 basis point undershoot on inflation in the medium term even when the Euro meltdown risk was excluded suggested that several MPC members are clearly considering up scaling QE2 as soon as possible. However, the chances of a majority of members voting for it at this stage seem low, although nothing can be said for certain in this environment. Poor data and further contagion inEuropethis week could cause a surprise here however. On the rate side, there are those who think that rate cuts are potentially coming, especially since many believe further cuts in ECB rates are on their way. Watch this space!

On the ECB front, market consensus is indeed for a 25bp cut to 1.00%, with risk skewed towards a 50bp cut. A number of policy decisions are also expected, primarily aiming at helping banks and fighting risks of credit crunch. We do not expect QE at this stage, but perhaps mention of it (or a similar mechanism) given certain conditions in the future.

On Thursday and Friday we get the EU leaders summit, where I do not see anything substantial enough coming out to really improve the current situation. The key points to look out for are possible reforms to theUnion, which may bring greater backing from the ECB. One way or another, the European crisis will not be solved this week, but we may at least see indications of the start of a credible plan. But have we not heard this before?

There is a lot of data to digest this week as well, as per the table on the next pages. Good Luck