Tunisia came as a surprise not only to the Arab world, but to everyone; it changed the rule of game. As I watched Mubarak’s speech on Tuesday I thought that not calling for early elections and an easy transition of power as his pledge to step down was dismissed as too slow. Clearly there is no return to status quo in Egypt, but is it a positive change? Certainly could be, but that remains to be seen. Yet the important question was will contagion effect be contained or will it spread similar to the Euro periphery sovereign debt story.
Looking at credit markets one can notice that credit markets price in limited contagion risk, at least so far. Credit spreads on sovereign entities in the Middle East started to widen sharply last November due to the political unrest that started in Tunisia. As the situation started to worsen, spreads widened as investors started to assign a higher probability to a severe political scenario in the Middle East and perceived greater market risk in the area. Interestingly, Egypt’s sovereign five-year CDS spread is now 433 bps, which roughly equals that of Portugal. Also, both countries have a B2 CDS-implied rating.
Two important gauges to consider monitoring in assessing the broader impact of events in the Middle East are the price of oil and the CDS spread of Israeli government debt. Thus far, the Suez Canal doesn’t seem to be under serious threat and there seems to be no interruptions to the flow of oil through the Canal. While oil prices have risen, investors still haven’t assigned a higher probability to a scenario of interruptions. As for the CDS spread of the Israeli government, the five- year spread has widened from 116 bps on January 26th to 145 bps on February 1st but not as much as the other countries in the region.
All in all, the market seems to price in a scenario of limited contagion risk as indicated by oil prices and CDS spreads.
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