MIG Forex Research

The fallout from the potential Dubai default continue to reverberate amongst the markets much as one would expect. For the country itself, CDS spreads have widened dramaticallyu with 5yr DPWORLD CDS being priced at 800-950 this morning - but bank shares have recovered a touch and the CDS is trading on the bid side.

Stocks generally remain under pressure and a flight to quality bid is helping both the US Dollar and the US treasury market. There remains the possibility the Abu Dhabi will step in and provide assistance - and if things get critical I expect this will occur. The market reaction again shows how easily people have jumped on the concensus trade and how vulnerable markets remain to aggressive counter-trend shakeouts.

The problems in Dubai have the potential to reemerge in many other regions of the world, with the eastern European corridor another potential trouble spot if the problems escalate.

As many people know I have not been a fan of the liquidity inspired rush to commodities/commodity currencies and much of that has to do with precisely these problems which I think will plague the markets for the next few years. The rise in Aussie and Kiwi dollars and the rise in many hard commodities has come about mainly due to artificial stimulus and not to sustainable long-term growth.

I think that by this time next year, hard commodities and the commodity currencies will be markedly lower than current levels, the US Dollar will be higher and both stocks and bond yileds will have drifted - the latter seeing significant curve flattening, even if some emergency front end rates have been taken back.

One thing to watch out for is the possibility of some Japanese intervention here. The breakdown in USDJPY has taken the yen relative to the Yuan to very elevated levels and as you know, I believe much of the rhetoric regarding the US Dollar weakening is actually directed at the Chinese and their very uncompetitive currency practices. Don't discount some unilateral Yen intervention if USDJPY heads significantly below 85.