WEEKAHEAD-Emerging debt faces rocky week on Iraq fears
www.forbes.com Reuters, 01.26.03, 5:17 PM ET By Susan Schneider
NEW YORK, Jan 26 (Reuters) - Emerging sovereign debt may endure a rocky ride in the week ahead as uncertainty about a possible U.S.-led war with Iraq remains center stage, pushing investors to the sidelines or prompting a retreat on fears of the economic fallout of a conflict in the Gulf.
The week promises to be a critical one for the U.S. campaign against Iraq. United Nations weapons inspectors are set to deliver the results of a two-month hunt for Iraqi weapons to the U.N. Security Council on Monday, and one day later, U.S. President George W. Bush will give a State of the Union in which he is expected to lay out his views on the threat posed by Iraqi leader Saddam Hussein.
The events will likely add to the war worries already weighing on the emerging debt market, giving investors more room for worry about a possible conflict's impact on U.S. stocks, the dollar and oil prices, said analysts.
"The next two weeks are going to be pretty telling," said Francis Rodilosso, a portfolio manager at Van Eck Capital. "I think the market is going to get increasingly jittery over near-term prospects for conflict."
The currencies of Latin America's two biggest economies -- Brazil and Mexico -- have already taken a tumble in recent days because of the war uncertainty. The Brazilian real and the Mexican peso slid last week in tandem with the U.S. dollar, which has fallen for seven straight sessions on Iraq fears.
The nervousness in U.S. equity markets, now at their lowest point since October, has also ricocheted across Latin America. Increased worries about the war are likely to be felt this week, particularly in market heavyweight Brazil, said analysts.
"There's going to be an increasing focus on the Iraq uncertainty and the question is the vulnerability of the U.S. equity markets," to which Brazil has looked for direction, said Siobhan Manning, Latin American debt strategist at Italian investment bank Caboto.
A recent survey by J.P. Morgan showed fund managers expect a war in Iraq would sink emerging market debt by about 1.5 percent in one day. The investment bank polled 181 institutions managing $136 billion in emerging market assets.
The survey also showed investors expected emerging debt spreads -- the premium paid over benchmark U.S. Treasuries to compensate for risk -- on the J.P. Morgan Emerging Markets BondIndex (Global) would widen 0.30 percentage points within a day. The current risk premium on the EMBI Global is around 7 percentage points over safe-haven Treasuries.
Still, investors underscored that the direction of emerging bonds is no easy call if the U.S. does lead a move to oust Iraqi President Saddam Hussein.
"There are an unimaginable number of potential outcomes to this conflict. There is a chance that the true military conflict part of it is pretty brief, and in that case we might actually see risk premiums come in," said Rodilosso.
"But there are so many potential unexpected outcomes that could result in higher risk premiums," Rodilosso added.
One chief concern is the impact of red-hot oil prices on global growth rates. U.S. crude prices shot up to a two-year high of $35.20 a barrel last week on the Iraq worries and the strangling of Venezuela's oil production by a general strike. They closed at $33.40 a barrel on Friday.
VENEZUELA WORRIES STILL LOOM
Among emerging economies themselves, Venezuela remains the key focus as the shutdown staged by foes of President Hugo Chavez extends into its ninth week.
The strike, aimed at forcing Chavez to step down or call new elections, has stifled oil output -- once the source of half the government's income -- and fired worries that the cash-starved government might default on its debt.
There are signs that oil production levels have climbed through the use of replacement workers, and Chavez also bought some time by closing the foreign exchange market for five trading days, a bid to stave off capital flight.
But with the crisis still unresolved, investors are wondering what steps Chavez might take next to ease the chokehold on the economy.
"The most important thing (in Venezuela) is the next move from the central bank. Are they going to open up the (foreign exchange) market or will it remain closed? Or will they introduce capital controls?" said Manning.
On Sunday, tens of thousands of Chavez foes clamored for early elections in the second day of a street protest in the capital, Caracas.
Chavez, meanwhile, told reporters in Brazil that the government was studying a tax on speculative financial market transactions as it tries to cope with the economic crisis. The leader was in Brazil to shore up support for his government at the World Social Forum.