Middle East Credit Downgrades and the EU's Rivalry with China

Hi all,

It is the thrid weekly publication of SeovereignBeat. We've been incredibly busy all week but have prepared a lot of exciting content for you guys. As Drake almost said it ‘Pound Cake’, ‘so we hope you enjoy reading this publication half as much as we enjoyed writing it for you’.

Now, let’s get straight to the business, shall we?!)

Markets Snapshot

• If red is your favorite color, or you like to short the market, you'd certainly appreciate the table above. For everyone else, equity markets continue to decline, with the S&P closing on Friday 10.3% lower than its peak on July 31st this year.

• Crude oil prices fell below $87 per barrel but bounced back to $90 by the end of last week. This rebound was initially attributed to increased expectations of a positive containment of the Israel-Hamas conflict and a larger-than-expected increase in storage reported by the Energy Information Administration. These expectations were dashed as Israel entered Gaza on Saturday, setting the stage for potentially more red market headlines this week.

• At least, the US crude stockpiles surged by 1.371 million barrels last week, significantly exceeding the expected 239 thousand barrels. Both the United States and Saudi Arabia have shown commitment to maintaining stability in the Middle East.

Global Finance

US Economy

The US economy recorded its swiftest growth since the fourth quarter of 2021, as the GDP saw a 4.9% annualized increase, up from the 2.1% in Q2 2023.

Implications:

• This growth was primarily driven by a 4.0% surge in personal spending. While business investment declined, residential investment increased for the first time in over two years.

• Despite the prolonged global surge in inflation that central banks around the world are still trying to address, including the Fed, the purchasing power and savings of U.S. consumers remain robust. In fact, even though many economists had anticipated that the U.S. would be facing at least a mild recession, growth has continued to exceed all predictions, with consumers accounting for approximately 68% of GDP in Q3.

• While it's arguable that increased consumption could stoke inflation and potentially delay the Fed in reaching its 2% target, traders are not predicting an interest rate hike at the central bank meeting next week, as per CME Group data. Futures pricing indicates a mere 27% likelihood of an increase at the December meeting following the GDP release. We must all admit, guys, when the crisis is fully over, the U.S. economy will be the first one to rock!

The Global Gateway - EU’s version of the BRI

The European Union's Global Gateway program, an unofficial alternative to China's Belt and Road Initiative (BRI), had its inaugural forum in Brussels on October 25. The 27-country EU had already unveiled over $69.6 billion in deals at the opening of the summit and proceeded to add $3.2 billion in new agreements with governments from Europe, Asia, and Africa. These deals focus on critical raw minerals, green energy, and transport corridors, addressing issues of transparency and environmental sustainability.

Implications:

• New agreements include partnerships with the Democratic Republic of Congo and Zambia for critical raw materials, and clean energy collaborations with Bangladesh, Cape Verde, Namibia, the Philippines, Tanzania, and Vietnam. Moldova secured a $12.6 million grant for rail line development, Turkmenistan is getting support to enter the World Trade Organization, and Tajikistan received $31.6 million for vocational education and training to boost green energy. The EU also invested $10.5 million in education with Armenia and $16.8 million to enhance safety along Georgia's East-West highway.

• While EU officials refrained from explicitly presenting Global Gateway as a rival to BRI, the Brussels summit coincided with China's celebration of the 10th anniversary of its $1 trillion global investment plan that gathered representatives from over 130 countries. Notably, the EU's focus seems to emphasize factors such as transparency and environmental sustainability, areas that have drawn repeated criticism in the context of Beijing's BRI. European Commission chief Ursula von der Leyen emphasized that Global Gateway is a "better choice" for financing and building clean infrastructure!)

• Global Gateway still lacks a clear strategy, primarily on how to incentivize private sector investment, with its $300 billion commitment trailing far behind the BRI's $1 trillion. Nonetheless, It offers emerging and frontier market economies an alternative to Chinese financing, reducing Chinese influence in Africa and Asia regions.

Ukraine

Ukraine's central bank has made a substantial rate cut of 400 bps to 16%, a decision supported by recent decreases in both core and headline inflation rates.

Implications:

• The central bank governor predicts that GDP growth will decelerate to 3.6% in 2024 following an anticipated 4.9% increase this year. They also lowered its 2023 annual inflation forecast to 5.8% from an earlier forecast of 10.6%. Reserves is projected to reach $41.8 billion this year and grow to $44.7 billion next year (Reaching an all-time high, even as the country allocates the majority of its budget to wartime efforts!)

• The substantial endeavor to reduce inflation from 26%, lower the key policy rate from 25% to 16%, and simultaneously boost reserves deserves significant recognition.

• It is hard to measure accurately the benefits of the purdent monetary policy during wartime. However, we can all agree that when the government faced with the task of covering a $45 billion budget deficit next year, the efficiency of the central bank become crucial for the sovereignty and independence of the entire country.

Credit Downgrades in the Middle East - More Storms to Come?

Both credit rating agencies Moody's and Fitch placed the Government of Israel's A1 long-term foreign-currency and local-currency issuer ratings on review for a possible downgrade. In the same period, S&P downgraded Egypt's rating for the second time in the month to B- from B.

 Implications:

• The Hamas-Israel war has indeed introduced significant uncertainties in the region from a credit perspective. All credit rating agencies, with particular emphasis on Moody's, express deep concerns about the geopolitical instability in the region. This instability not only impacts the growth rate and government revenues but also hinders progress in ongoing reforms and increases external risks in the affected countries, among other detrimental effects.

• Palestine is not rated by the three main credit agencies mentioned above for the reason you have probably already guessed: its non-official status as a sovereign state. Therefore, it was anticipated that, among others, Israel would come first under fire from rating agencies, given its direct involvement in the current military conflict.

• To be fair, Egypt was primarily downgraded due to delays in implementing monetary and structural reforms, negatively impacting the foreign asset position of banks, and delaying essential IMF disbursements. This country merits a dedicated section in this newsletter, as it is a great example of a poor macroeconomic management practices. It provides us with valuable lessons on what exactly you should avoid doing if you don’t want to fuck up your own country. Yet, S&P has raised concerns about Gaza and its potential spillover effects on Egypt, hinting at potential new challenges looming for the nation if the conflict crosses over its borders. ( Let’s say only in the context of the number of refugees that would eventually flee to Egypt)

• Meanwhile, agencies started reviewing other countries in the region and more downgrades can be expected. The consequences are robust: deterioration in credit accessibility, increased borrowing costs, reduced investment, and an overall economic growth decline.