Busch: Egypt's Risk for Bernanke and Fed Policy

Back in December, I wrote a piece entitled “Top 5 problems for 2011”. In it, I stated this:

5. Food Inflation. Isn't this really the most under-reported story of 2010? Since June, wheat is up 60% and corn is up 74%. Food accounts for up to half of all household spending in emerging countries compared to just 10-15% in Europe and the US according the FT. China has increased reserve requirements and raised interest rates because their CPI is running above 5.0% and food inflation is running above 10% and vegetables up 21%. Mexico bought call options on corn this week as Mexican tortilla makers threatened to raise prices by 50% to offset higher corn and natural gas costs. If the price of food continues to soar, social unrest is likely to occur in the EM countries and disrupt economic growth.

The protests over food and unemployment started in Tunisia. After that country’s long time ruler was overthrown, the protests spread to Egypt.Egypt is one of the world’s largest importers of wheat.

Also, Egypt controls the Suez Canal and therefore is a conduit for Middle East oil. The Middle East has about two thirds of all the global oil reserves and about half of all the gas reserves. For the markets, I believe we’ll see a reversal of Friday’s movements as things calms down and investors adjust to the risk. But the potential risk is not over.

This weekend, the Mubarak government has made political moves to announce a vice president, announce a new prime minister but not announce that Mubarak is leaving. The concern for the region is what type of government would be put in place if Mubarak is forced to leave. A radicalized Egypt would call into question the Camp David accords with Israel that demilitarized the Sinai Peninsula. It would also embolden further protests in the region and possibly destabilize other regimes of a similar ilk.

Today, the violent protests have calmed down and the global financial markets are reacting positively with the Euro and commodity prices rallying. However,Moody’s downgraded Egypt to Ba2 from Ba1 and the Egyptian 2020 bond rate jumped from 6.98% to 7.42% as investors built in a risk premium. There is a planned demonstration of one million people for Tuesday and one shouldn’t be lulled into a belief this is over. There are ebbs and flows in social unrest as political moves are made, digested and then reacted to by the population.

"If the street chants in Cairo shift from “Death to Mubarak” to “Death to the US”, then something truly dangerous will have been started."

From riots to tighter monetary policy, food inflation will continue to drive global instability. Watch to see if foreign politicians and central bank governors begin to ramp up their criticism of the US Federal Reserve monetary policy that is perceived as a cause of the global inflation. Brazil’s comment of a “currency war” is beginning to appear clairvoyant. (Today on CNBC, Pimco’s El-Erian said that the Fed’s policies leaked out to the emerging markets and Egypt.)

If the street chants in Cairo shift from “Death to Mubarak” to “Death to the US”, then something truly dangerous will have been started.

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    Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.