Last Thursday, Dubai’s quasi-default on a $3.5 billion bond sent shockwaves through the global credit markets. The Dow fell 154 points, with all 30 components down. Only four stocks in the S&P 500 were green on the day. As we noted on Friday morning, however, holiday trading can be exceptionally volatile.
 
The government of Dubai stated that its state-controlled holding company, Dubai World, does not have a financial guarantee from the government and therefore its creditors must deal with the issue. To draw a parallel, this would be like Washington disowning the debt of Fannie Mae and Freddie Mac.
 
Since so many governments have now backstopped their financial institutions, additional instances of such sovereign distancing would be a worst case scenario. Dubai itself is not an oil producing emirate, so it lacks a separate source of income from its role as a diversified business and resort destination. That makes it more vulnerable to the boom bust cycle associated with bubbles.
 
Dubai is one of seven Emirates and the most populous. Over the weekend, the U.A.E.’s central bank stepped in with loan guarantees. The U.A.E.’s banking industry is the largest among the six Gulf Arab states including Saudi Arabia, with over $400 billion in assets. Credit default swaps on Dubai debt are trading around 6- 7% at this time, which is not indicative of an imminent default.
 
Emerging markets in particular felt the chill on Friday, with various indices down 2-4%. This morning, however, the mood is much better. The Hong Kong index is up more than 3%.

Meanwhile, investors in the U.S. are appreciating the fact that retail sales over the weekend were on par with last year.
 
After a brief rally, we nevertheless expect the market to retest Friday’s lows.