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SAMA Sparks a Fire

Markets react to SAMA 's silence. UAE cuts CD rates for the second time, but speculation on the currency increases. A move by Saudi may trigger a multilateral move.
UAE cut rates but no sign of SAMA
The Saudi government has yet to officially release an addendum to the Saudi Central Bank Governor's statement on Wednesday stating that there was no need to change rates. Markets believe that something has to give and are reacting to the silence of SAMA . Speculation on the Saudi riyal persists, and has remained at its 21-year high levels. If the Saudi government chooses not to cut interest rates, markets are assuming that they may have to revalue. This "wait and see" game has increased speculation on the currency. With Saudi's currency policy called under question, the UAE is also being carefully watched by the markets.

Unlike Saudi, the UAE has responded to lower US rates by reducing rates as well. Initially, the UAE followed the Fed by cutting one week, one month, and 3 month CD rates by 15 bps and its 6 and 9 month rates by 20 basis points. Yesterday, they took further action by cutting the three month CD rates by another 10 bps, leaving 3mth rates at 4.7%, 6mth rates at 4.8%, and 9mth rates at 4.7%.

Despite the cuts, speculation for an AED revaluation has yet to ease. This is not just because of UAE specific factors. We have been arguing for some time that because of the higher inflation in the UAE, in real terms the AED does not appear to be undervalued.

Furthermore, inflation in the UAE is driven by domestic factors, namely the cost of housing. There are indeed problems with the USD peg when it comes to the UAE, but these problems are mainly the result of the lack of flexibility rather than the valuation of the AED.

The reason behind this increased speculation on the AED, and on GCC currencies in general is to an extent related to Saudi Arabia. The economic arguments favouring an SAR revaluation is based on more sound economic arguments. Inflation in Saudi Arabia is rising, but it is still much lower than inflation in Qatar or the UAE. This suggests that in real terms, the SAR has not been appreciating. Furthermore, the main drivers of inflation in Saudi Arabia are not just domestic factors. A stronger currency would actually help contain inflation.

But it is not just about the economic arguments. The presence of the USD peg and the unwillingness to cut rates at a time when the Fed is cutting, have raised question marks over the sustainability of the peg. The SAMA has kept quiet and the market's questions have not been answered. Markets are therefore becoming increasingly nervous, and this is spilling over to the rest of the region. The perception in the markets is that if Saudi, the biggest economy in the GCC region, decides to revalue, the UAE will have to move as well, especially if one takes into account all the rhetoric that exchange rate reform will be multilateral.

It is also worth remembering that a time when the markets are speculating over GCC currencies, Kuwait has already scrapped the USD peg. And according to our estimations, the KWD currency basket is still beyond its recent highs, despite the fact that Kuwaiti authorities have allowed the KWD to strengthen against the USD. The USD index (DXY) was extremely close to its all time lows of September 1992. The all time low was at 78.19, and the low yesterday was at 78.21. These are important support levels and a daily close below these levels could signal more short term USD losses, which could make it easier for the Kuwaiti Central Bank to allow for more KWD strength.

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