Matein Khalid: Iraq Crude Oil And Global Markets
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Matein Khalid: Iraq Crude Oil And Global Markets

Matein Khalid: Iraq Crude Oil And Global Markets

Real and close geopolitical risks will not leave any major market unaffected, writes Matein Khalid, a global equities investor and advisor to regional family offices.

Gulf Business

The tragic news from Iraq and Ukraine has meant that real geopolitical risks now haunt Wall Street. If these geopolitical risks in crude oil and financial markets remain elevated for a protracted period, the US dollar will be bid higher as a “safe haven” asset, along with the Japanese yen and the Swiss franc.

The US dollar’s performance since the summer 2013 “taper tantrum” has been mediocre due to unmet expectations of US economic growth, Janet Yellen’s monetary dovishness and unwillingness to hike the Federal Reserve’s key overnight borrowing rate.

However, Iraq is a game changer because it increases deflation risk in Club Med and core Europe via a higher Brent crude oil price. This means the ECB and the Bundesbank will have to give the green light to Dr. Draghi’s plans for unorthodox monetary policies, possibly even a Bernanke style quantitative easing.

Note that Europe has its own share of political risk, given the victory of anti- EU, anti-capitalist right wing parties, such as France’s National Front, in the European Parliament.

Reserve managers at central banks had bid up the Euro to 1.38 but have been afraid to add to their exposure given Dr. Draghi’s “I am not finished” warning to the Euro bulls.

Now that Italian, French, Greek and Spanish yields have plummeted to epic lows, there is no “carry trade” flows to sustain the Euro. If Brent rises to $125, the timetable for an ECB QE move accelerates in order to preempt recession and another banking “credit crunch” in the Old World.

Of course, the Fed’s monthly asset purchase taper could well end at the same time as the Federal Reserve turns more hawkish on US inflation and interest rates. Almost $800 billion in offshore capital has bottom fished in European debt and securities since mid-2012.

However, $125 Brent and a minus 0.1 per cent ECB bank deposit rate is no longer an argument to buy European assets. So carry, reserves, Iraq, oil, ECB, European politics and offshore capital flows all tell me that the Euro is on the precipice of a major fall, down to 1.30 if the civil wars in Iraq, Libya and Ukraine escalate.

Since I expect dollar strength, I am nervous about emerging markets. Turkey, Egypt and the Gulf markets cannot attract global fund managers if an Arab state in the heart of the Middle East begins its geopolitical death rattle. Note that Dubai’s DFM index fell 12 per cent in the two sessions after the ISIS militia seized Mosul and Kirkuk, then massacred 1,700 captured soldiers of the Iraqy Army’s Fourth Division in Salahudin Province.

Turkish military intervention in Iraqi Kurdistan is also possible since the Peshmarga has violated Ankara’s “red line” and seized Kirkuk, the potential capital for an independent Kurdish state that Turkey will not permit.

Even “popular” emerging markets such as India are vulnerable to oil price spikes at a time when the Reserve Bank of India (RBI) must tighten policy to combat a wholesale inflation spike. A Brent spike is also a disaster for the Indian rupee, since 70 per cent of the current account deficit is due to crude oil and gold imports.

So I recommend taking profits on the Sensex at 25,000, now that the Modi- BJP win and reform agenda is fully priced into a stock market that trades at 15 times earnings.

I am extremely negative on Turkey, whose lira is overvalued, whose current account deficit is eight per cent of GDP, whose banks are burdened by $250 billion in consumer loans, and whose military could well be forced to intervene in Syria and Iraq.

The political opposition in Turkey against Prime Minister Erdogan’s Presidential ambition will only amplify funding risk in Turkish assets as offshore funds slash lira exposures. The World Bank has downgraded emerging markets, an ill omen for an exporter like Turkey.

Turkish corporates borrow in US dollars and export in Euros. A financial time bomb is ticking in Ankara.


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