Tags: Iraq | oil | dollar | US

We're Seeing the Beginning of the End of Iraq As We Know It

Tuesday, 17 June 2014 11:05 AM Current | Bio | Archive

Long-term investors should take into account when making investment decisions that Iraq has a more than 50 percent possibility of disintegrating as a country into at least three areas (North, West and South), unless a wonder occurs, which is of course extremely rare but can happen.

Because last week I saw well-equipped Sunni soldiers in Iraq refusing to fight for Prime Minister Nuri al-Maliki and his central government, which had alienated them because they were Sunnis, and saw them throwing away their weapons and uniforms and either fleeing or surrendering to the Islamic State in Iraq and the Levant (ISIS) insurgents, I don't think it's an overstatement to say we're probably seeing the beginning of the end of Iraq as we have known it since the American military left a couple of years ago.

It's a fact in Iraq that the Sunni military units as well as the population of Northern, Western and Central Iraq despise al-Maliki's anti-Sunni, pro-Shia government, which has purged Sunnis from leadership positions in al-Maliki's cabinet and military. No wonder the Iraqi Sunnis consider their government in Baghdad contrary to their interests because it has mostly operated now for years as a repressive and/or corrupt entity against Sunni interests as a whole.

All that should have its consequences in the future on the worldwide energy situation and on oil prices in particular, which certainly haven't priced in yet the still-developing risks that the whole situation represents for years to come.

For now, as the conflict zones remain, broadly speaking, limited to the north and west in Iraq, there is relatively low probability we'd see a sudden spike in oil prices because Iraq's main oil export terminal is located in the deep south of the country, near the city of Basra, which has access to the Persian Gulf and isn't under ISIS threat yet.

I'd like to underline that no worst-case scenario is bad enough for Iraq, since "contamination" even in a country like Saudi Arabia and others can't be excluded and therefore sharp spikes to $130 to $150 a barrel can't be considered as impossible. Please keep in mind, in case the markets should hit these prices, these prices would stay elevated for a prolonged period of time and practically all equities in most, if not all, places on the globe would literally tank to levels that very few consider as possible today.

As we say, stay tuned and see how the Iraqi quagmire further develops on its way into a multi-year-long blind alley.

By the way, on Tuesday, the International Energy Agency (IEA) stated most medium-term OPEC crude oil capacity growth has to come from Iraq.

The IEA also raised its forecast of demand by 900,000 barrels per day to 30.1 million barrels a day and said the world oil market is, in many ways, considerably tighter than it was a year ago.

That said, the dollar index and oil prices have started acting as something like a mirror image of each other. The question is if that could continue to be the case.

I don't think that should be the case, because for now it doesn't seem likely we should expect U.S. military involvement in Iraq (boots on the ground), therefore I don't expect any specific related weakness of the dollar.

Please keep in mind that most U.S. military involvements in conflicts in the Middle East have usually had a fairly direct negative impact on the dollar. The only exception to this was when U.S. troops were deployed in Lebanon between mid-1982 and early 1984, but also then, in the latter stages of the operation, we saw the dollar coming under some pressure.

Nevertheless, it could be worth keeping this dollar relationship in mind as events in Iraq continue to unfold, good or bad, for quite some time to come.

Besides all that, on Monday we got in some not-so-pleasant information that at the Federal Reserve senior-level officials have discussed the possibility of imposing "exit fees" on bond funds in order to avert a potential run by investors in case a crisis of confidence should erupt. It's an undeniable fact these discussions at the Fed demonstrates its concern about the vulnerability of the $10 trillion corporate bond market.

We all know the vast majority of investors don't take this situation into consideration or simply don't know the assets held by their funds are long-term instruments that could be hard to sell when troubles pop up.

Only a couple of weeks ago, Jeremy Stein, outgoing member of Fed's Board of Governors, described it perfectly when he stated the open-end corporate bond and loan funds had given their investors the wrong perception they had some kind of liquid assets when he stated: "It may be the essence of shadow banking is . . . giving people a liquid claim on illiquid assets."

But don't worry yet, because imposing exit fees would need a rule change at the Security and Exchange Commission. However, it's probably a good idea to put it on your watch list in case you'd have such a type of investment.

Finally, Tuesday the Fed will start its two-day meeting and announce its rate decision Wednesday. Also, Fed Chair Janet Yellen will give her second press conference. I don't think any policy changes are in the cards.

Maybe more interesting could be the updates of both 1) the Fed's economic projections now that the International Monetary Fund has downgraded GDP growth expectations for the United States to 2 percent, down from 2.8 percent, and 2) the Fed's "dots" plot where the Federal Open Market Committee members show their expectations on future Fed funds interest rates.

Remember in March, the dots pointed to an average 1 percent Fed funds rate in 2015 and an average Fed funds rate of 2 percent to 2.25 percent in 2016, which were slightly higher marks than in the December 2013 expectations. We'll see if the expectations continue on the higher side.

Anyway, if the situation in Iraq as well as in the other known geopolitical hotspots — from the Ukraine, the South China sea, Syria and so on — don't get completely out of hand, I can't see any other way for interest rates than to start moving up next year, and most importantly, in the United States and the United Kingdom. The day it really starts, it won't be good news for the emerging markets in general.

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If the situation in Iraq as well as in the other known geopolitical hotspots don't get completely out of hand, I can't see any other way for interest rates than to start moving up next year, and most importantly, in the United States and the United Kingdom.
Iraq, oil, dollar, US
Tuesday, 17 June 2014 11:05 AM
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