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Inflationary turm-oil in the Middle East

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Carl Shepherd, the emerging markets specialist in Newton’s fixed income team, casts his eye over the Middle Eastern crisis and looks at the likely effects of the tensions on asset prices around the world.

 

“Since the turn of the year, we have seen widespread popular unrest across North Africa and the Middle East, with revolutions in both Tunisia and Egypt, and increasing pressure on Colonel Gaddafi’s leadership in Libya,” says Shepherd. “While international authorities see this as a forward step in terms of creating a more democratic region, it is not as simple as just deposing a government or figurehead.

“Unlike the rule of dictatorships, which tend to provide a certain amount of stability – albeit maintained by force and fear – with change comes uncertainty, and the first few faltering steps of democracy often accompany more uncertainty than was present under the preceding dictatorship,” he explains. “In most cases there is no clear replacement leader or government primed to step in and lead these countries. As such, there is a very real chance of continued instability as various factions vie for political power. This will be no quick fix, and against this backdrop, it seems possible that an international presence will be needed to oversee political change; something which is ultimately undesirable,” he adds.

“Bond markets will no doubt be affected by such uncertainty, and we expect to see a widespread revaluation of political risk across emerging markets, especially in those which lack government transparency,” explains Shepherd. “The value of stability and a solid institutional framework has perhaps been under-appreciated recently, and we expect this to change. We also expect an increased focus to fall on those economies whose political structures follow a dictatorial or autocratic model. Among frontier markets, Belarus and Gabon are likely to fall into this category,” he adds.
“We expect the inflationary effects of the current unrest to be felt around the globe, as fuel prices continue to rise. There is also the possibility of a flight to quality, with investors seeking the relative ‘safe havens’ of US Treasuries and the Japanese yen,” he says.

“Elsewhere, the oil price remains under pressure, although the current spike is not based on oil fundamentals, but on supply concerns relating to the Middle Eastern unrest, as Arab states outside the Arabian peninsula such as Libya and Algeria possess significant fuel reserves.” Shepherd continues, “Furthermore, as well as the significant oil reserves within affected countries, instability across the Gulf region and in Yemen also damages the stability and viability of the major oil shipping routes in the straits of Hormuz and the entrance to the Red Sea.”

Meanwhile, in terms of fixed income positioning, the team currently has no direct exposure to those Middle Eastern countries dominating the headlines at present. Shepherd explains, “Towards the end of last year, we had a small position in Tunisia, however, we sold out before the turn of the year, not as a result of our powers of prediction, but simply because we didn’t feel that they provided enough value given the traditional risks associated with the region. Ultimately, this has been proved correct. Looking ahead,” he concludes, “given the recent spike in oil prices, we see opportunities in those countries, such as Russia, Venezuela and Colombia, which are net exporters of oil and gas but are geographically removed from the affected region. We consequently added to, or maintained, our holdings in government bonds issued by these nations.”

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