Will this be another dead cat bounce?

You have to give the “masters of the universe” on Wall Street some credit. Yesterday, they looked into the abyss in the wake of the Bear Stearns collapse, and for a moment wavered on the brink of disaster for the global financial system. But their nerve held, and they pulled back.

We should all be grateful for that, but it does not mean the danger is passed. Equity markets rebounded yesterday – partly in reaction to Wall Street’s sang-froid, and partly in anticipation of an even bigger cut in Fed rates than previously suggested (as much as 1.25 per centage points was being mentioned by some optimists).

But whether that turns into the infamous “dead cat bounce” will depend on events over the next few days and weeks. The financial system is still in critical condition.

There is the persistent risk that another US or European bank or financial institution will go the route of Bear Stearns, despite the better-than-expected results from Lehman Brothers and Goldman Sachs; HBOS and Royal Bank of Scotland in Britain both saw damaging runs on their shares in London on Monday; and Société Générale cannot be completely out of the woods over its rogue trader scandal.

It would be very difficult for the Fed or any other central bank to find another rescuer for any of these institutions, as it was able to do with JP Morgan Chase and Bear Stearns. There is still the very real possibility that a major institution will go bust.

Another danger is looming too, and this presents a very serious threat. We have been used to living with rising commodity prices for several years, but, as some experts have pointed out, that may not be the case much longer.

World commodity values have continued to hit record levels mainly due to continued demand from the still growing economies of China and India. But in the case of a major economic slowdown in the US this demand will fall off sharply.

Commodities have become the safe haven for investors frightened by falling equity and credit markets, and as much as 50 per cent of trade is what the experts call “non-commercial” – in other words, speculation by hedge funds and individuals. If this vanishes, another leg to the asset-value chair will be knocked away.

One American banker summed up the situation ominously: “We no longer have a liquidity problem, we are now facing an insolvency problem. The values of all our assets are deteriorating rapidly.”

The Fed’s next move – after it cuts interest rates – must recognise this, and begin the painful process of downgrading the credit ratings of all US financial assets.

There is, however, a silver lining in all this doom and gloom, and the financial authorities in the Gulf should see that they have a one-off opportunity to implement a long-overdue policy change.

Events in America mean that the dollar-peg for the Gulf countries no longer makes a shred of sense. The Fed rate cut will add to inflationary pressures, especially in the UAE, and will make no difference whatsoever to the personal financial situation of the man in the street.

Banks here, as they have done in America, are simply taking the opportunity to restore damaged profitability by putting lending rates on hold while cutting deposit rates.

The markets have already begun to weigh the alternatives to the existing dollar peg: depegging, revaluation or the introduction of the euro into the equation. The region’s central bankers will never have a better opportunity than this to de-couple from the American financial disaster.