Investors in the region are expected to focus on defensive stocks this week as US legislators struggle to resolve an impasse on raising a US$14.3 trillion debt ceiling to avert a debt default.
With just two days remaining until the country faces a technical default, Barack Obama, the US president, on Friday told a deeply divided Congress to stop arguing and find a way "out of this mess".
"Whatever happens throughout the next few days is really going to set the pace for international and regional markets," said Marwan Shurrab, the chief trader at Gulfmena Investments in Dubai.
The Abu Dhabi Securities Exchange (ADX) General Index dropped 2.5 per cent to 2627.99 points last week, while the Dubai Financial Market (DFM) General Index dropped 1.3 per cent to 1,506.13.
The UAE Central Bank said on Friday it holds no US treasuries or other government financial instruments and reiterated its support for the currency's peg to the dollar.
"Despite the fact that the Central Bank foreign reserves are mostly denominated in US dollars, they are invested mostly in non-US assets," the bank said.
A much awaited up-tick in trading activity as investors return from their summer holiday ahead of the Islamic month of Ramadan is likely to be overshadowed by the US debt debacle, said Mohammed Ali Yassin, the chief investment officer at CAPM Investments in Abu Dhabi.
"We can't talk about what is happening in Ramadan for local markets without talking about what is happening to the US, which is unfortunately dragging into the first week of the holy month," Mr Yasin said.
Traded value on the local bourses ADX and DFM reached Dh160 million on Thursday, down from the Dh300m daily average in the past six months.
"Foreign investors will definitely not be in our markets in Ramadan because they have bigger things to worry about," Mr Yasin said. But high-net worth investors will be looking closer to home as global equities appear to be more risky, he said.
Institutional investors said they would be positioning in defensive stocks in Ramadan as a hedge in times of heightened volatility.
"The theme for this month is consumer related, not property, banks, or growth-related stocks," Mr Shurrab said. "We allocated our portfolios shares of Abdullah Al Othaim, Saudi Arabia's second-biggest supermarket giant, and Almarai, the country's biggest food and dairy producer."
Regional markets were not immune last week to the growing concerns about the failure of Congress to reach an agreement on lifting the US debt ceiling.
Kuwait's measure lost 0.9 per cent to 6036.00 points, Bahrain's index was little changed at 1298.50 and Oman's measure lost 1.6 per cent to 5848.66. Qatar's benchmark lost 0.3 per cent to 8377.00 and the Saudi Tadawul All-Share Index lost 1.3 per cent last week to close at 6445.17 points.
World stocks headed for their biggest weekly loss in almost a year on Friday as investors piled into safer assets. In the US, the Dow Jones Industrial Average lost 0.7 per cent to 12,143.20 points. In Europe, the FTSE 100 Index lost almost 1 per cent to close at 5815.19 points.
In Asia, Japan's Nikkei 225 Index was down 0.6 per cent to 9833.03 and the MSCI World Index fell 0.5 per cent on Friday to 1306.05. The benchmark index fell 2.8 per cent and was on track for its biggest weekly loss since August last year.
The Swiss franc, a traditional haven currency, rose to record highs against both the dollar and the euro, and gold prices soared to a record high above $1,630.