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Storm clouds gather over sterling for Dubai investors

An impending UK recession against a backdrop of Chinese deflation could see a flight to the dollar

Labour Party leader Sir Keir Starmer Reuters
Labour's Keir Starmer has a strong lead in the UK but could become prime minister of a country in recession

Dubai’s royal and merchant elite has always had a significant financial exposure to UK PLC, and thus sterling.

The historical umbilical cord between Britain and Dubai goes back to even before the birth of the UAE Federation in December 1971.

The late Sheikh Rashid al Maktoum, the father of the current ruler of Dubai, was a frequent guest at Buckingham Palace, Windsor Castle and Sandringham.

At his request, the UK government upgraded the pre-1971 political agency on the Deira Creek to a British Embassy, as he wanted to retain Dubai’s direct link to the Crown.

Therefore, the UAE is the only country in the world where there are two British Embassies.

Unfortunately, despite this long relationship, I see storm clouds for the pound in the next six months.

King Dollar has begun an alarming ascent in the past month, a magnet for safe-haven capital flows as China’s $18 trillion economy tanks into a deflationary black hole.

Property market woes, a shadow banking crisis and 30 percent-plus youth unemployment rate represented a political threat to imperial dynasties for millenia, and do so to the Red Emperor’s Politburo now.

The “tough love” message delivered at Jackson Hole by the Federal Reserve’s Jay Powell suggests that the Fed Funds rate will remain at 5.5 percent or even inch higher, as the inflation rate is still double the American central bank’s two percent dual mandate target.

The dollar, in turn, depresses crude oil prices, which are vulnerable to China diesel demand shock, debt distress in emerging markets, the Biden White House’s new diplomatic rapprochement with Iran and Venezuela, and increasing evidence of credit market stress in the US.

There, bank loan growth is slumping, US Treasury bond yields are rising and $1 trillion in corporate debt needs to be refinanced in both 2024 and 2025. 

Moody’s bear scenario estimates that the corporate default rate will rise from its current 3.8 percent to as high as 13 percent, the highest since the death rattle of Lehman Brothers in the fateful autumn of 2008.

These auguries are all bearish for the British pound at a time when the oil-driven business cycle in the Gulf is set to peak.

Prepare for losses

Markets trade on expectations and not events. So I expect a mini sterling crisis to emerge in the next six months.

It will be a pale shadow of September 1992 under the then prime minister John Major, or even September 2022 under Liz Truss, but it can still cost unhedged Gulf investors colossal FX losses.

The sceptred isle faces an increasing economic malaise even as the US economic growth re-accelerates, as the Atlanta Fed’s GDPNow model of an annualised 5.8 percent in Q3 now suggests. 

Despite the Bank of England’s 14 successive base rate hikes at its monetary policy committee conclaves, Britain’s inflation rate is still the highest in the G7.

Sir Keir Starmer’s Labour Party has a seemingly unassailable 20 point lead in the polls over a plutocrat Tory prime minister elected only by his fellow grandees in Westminster after the Trussonomics debacle last September.

Despite its interest rate anchor, sterling is in danger of sinking against the US dollar as the UK economy slips into recession on the eve of a general election that could see the first Labour PM in 10 Downing Street since Gordon Brown left office in 2010.

The history of Planet Forex demonstrates that relative economic growth trumps interest rate differentials when sterling faces recession and rising political risk.

I also believe sterling is overvalued against the yen as the Empire of the Rising Sun faces a torrid 6 percent annualised GDP growth rate and 3 percent inflation.

Sooner or later, Bank of Japan governor Kazuo Ueda must act – well before cherry blossoms bloom on the sacred slopes of Mount Fuji.

These are all telltale signs of an embryonic sterling crisis.

I would appeal to my fellow chief investment officers and the currency gnomes of the Creek to hedge their exposure before it is too late.

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm

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