BondSquawk

January 31, 2011

An article in WSJ exposes a risk of investing in emerging markets by pointing to the possible contagion effect of the Egypt crisis:

Egypt is sending investors a wake-up call about the risks in emerging markets. For two years, investors have poured money indiscriminately into emerging-market assets that looked safe relative to stocks and bonds from debt-laden developed economies. But declines in U.S., Asian and European stocks and the rally in oil, bonds and gold reflect the real risk the Egyptian unrest triggers contagion that could affect the global economy.

One risk is that the political turmoil may spread. Tunisia and Egypt are reminders of how volatile and unpredictable emerging markets can be and that this needs to be reflected in their cost of capital. That could trigger flows of capital out of emerging markets back into developed markets, already buoyed by the brighter growth outlook for the U.S. Middle Eastern stock markets were hit hard at the weekend, and the cost of insuring the debt of sovereigns, including Morocco, Saudi Arabia, Qatar and Lebanon, has risen.

A second possible source of contagion is via the oil price, which spiked 4.3% to $89.34 a barrel in New York Friday. Investors are concerned by the risk of closure of the Suez Canal, which accounts for 8% of global trade flows including about one million barrels a day of oil and refined products, and the potential for protests in big oil producers like Libya or Saudi Arabia. Oil markets have been tightening as demand has built thanks to the global recovery; further rises could squeeze consumers in developed markets where incomes are already under pressure.

A third risk lies in the response to the high food prices that are one of the factors behind the social tensions in North Africa and the Middle East. That raises the possibility of a policy error: Monetary policy makers might tighten too quickly to stamp on inflation, or governments might try to ease the impact of price rises through food subsidies, weakening their fiscal positions.

Contagion will have winners as well as losers. Russia would benefit from higher oil prices; Brazil and other Latin American countries stand to gain from higher agricultural and commodities prices. But even if the turmoil in Egypt subsides, one lasting impact should be greater discrimination between emerging-market countries.

January 31, 2011

Moody’s downgraded Egypt’s government bonds, giving them a negative outlook from a stable one, as reported by the Wall Street Journal this morning. This comes as a result of the political unrest in the country and the increased event risk that it has caused, said Moody’s.  This comes at a very critical time for the nation’s economy, as banks are closed and production lines stopped. The stock market of the country remains shut after falling 17% before the weekend. Tourism already stands at risk of being adversely affected, which will cut one of the top sources of foreign revenue of the country. A downgrade at this time can increase the economic and fiscal tensions of the nation. WSJ reports:

DUBAI—Moody’s Investors Service Inc. on Monday downgraded Egypt’s government bond ratings to Ba2 from Ba1 and changed its outlook to negative from stable, citing political risk.

The ratings agency warned that the Egyptian administration’s policy response to recent unrest could undermine the Arab republic’s already weak public finances.

Moody’s also cut Egypt’s ceiling for foreign-currency bonds to Baa3 from Baa2 and the ceiling for foreign-currency bank deposits to Ba3 from Ba2.

“Moody’s decision to downgrade Egypt’s government bond ratings is driven by increased event risk,” Moody’s said in an emailed statement. “This has resulted from escalating political tensions in the country following the recent uprising in Tunisia, with large-scale antigovernment protests taking place.”

Moody’s warned that “rising inflationary pressures” would further complicate Egypt’s “fiscal policy by threatening to increase the high level of budgetary expenditure on wages and subsidies.”

Moody’s is the first of the three major credit ratings agencies to downgrade Egypt since the protests kicked off, leaving its rating one notch below the other two agencies. Fitch Ratings and Standard and Poor’s Corp. have BB+ ratings on the North African country.

However, Fitch Ratings lowered the outlook on its rating to negative Friday, saying a downgrade could be imminent if the political unrest escalates.

In a report last Thursday, S&P said economic risks and fiscal pressures for the region have been heightened in Egypt, Algeria, Jordan, and “to a lesser degree, Morocco,” because of the revolt in Tunisia in mid-January.

By Maulik Mody – Bondsquawk.com

January 31, 2011

Consumer spending increased more than forecast in December, making the last quarter the best one of 2010. Spending increased 0.7% in the last month, following a 0.3% gain in November. Personal income grew for a third month in a row, continuing to grow at 0.4%. Although income and spending continues to grow, the pace is moderate making the recovery very slow. The Fed’s preferred gauge of inflation, the Personal Consumption Expenditure Core Price Index, was flat in December after advancing 0.1% in November.

However, data continues to show that manufacturing activity is gaining and is driving the recovery in the U.S., as seen in the Chicago Purchasing Manager index, which jumped two points in January to 68.8 from 66.8 in December. This is the highest level since 1988, as most components of the index came in stronger. New orders came in at 75.7, much stronger from 71.3, while employment strengthened to 64.11 from 58.4. These are reportedly the highest levels these components have reached since 1984. While production also picked up, inventories declined from 60.0 to 54.5.

The ISM-adjusted index increased to 65.6 from the high 65.0 in the previous month. The ISM manufacturing index is expected to level off a bit in January. The other regional manufacturing surveys have been mixed, with Kansas and Richmond declining, and Philly and New York increasing. The Chicago PMI index has remained the leader among the regionals, now nearly 10 points above the average of 56.1 for the four other surveys.

The Dallas Fed Manufacturing Activity Index came in at 10.9 in January, following an upwardly revised reading of15.8 in December and missing economists’ expectations of 15. Production fell drastically to 0.2 from 15.3, and capacity utilization slumped to 4.1 from 18.8. New Orders increased slightly to 12.7 from 11.3 the previous month.

Stocks were stronger on improved economic data, with both the NASDAQ and Dow Jones trading 0.2% higher. The S&P was last seen at 1281.81, up 0.4% since yesterday. Rates were mostly flat in the belly region but rose in the further end of the curve. The benchmark 10-Yr note traded 2 bp higher at 3.34%, as did the 30-Yr Bond at 4.55%.

The political turmoil in Egypt diverted market attention Friday from the advance estimate of Q4 GDP, which was a little softer than market expectations at 3.2% Q/Q but strong in the details. This coming week will shed more light on the carry through of the economic momentum into January. The ISM might indicate continued strength in manufacturing while the non-manufacturing ISM will cool just a little reflecting softer retail activity in January.

Meanwhile the January payroll report will point to continued moderate improvement in the overall pace of hiring. Expect a gain of around 110K after a 103k advance in December. The economy increasingly shows signs of a self-sustaining momentum, although the hiring picture has shown less acceleration so that some moderation from the surge in final demand is likely in Q1. Chairman Bernanke will give a talk at the National Press Club on the eve of the employment report. He can be expected to maintain the Fed’s conviction in QEII.

Courtesy: BNP Paribas