Tensions in Egypt continue to remain in the spotlight, reinforced by concerns about China and Eurozone inflation. The Euro is higher today against the dollar on better equity risk sentiment, and strong inflation numbers that have made some believe that the ECB may raise rates. Oil is holding above $90 per barrel, while gold is rebounding from its recent lows in the $1320s and trying to find a ground. Markets are unwilling to take the Egypt events very seriously so far, perhaps hoping that the regime will be toppled soon without much more bloodshed and turmoil in the area. But even if that turns out to be the case, the removal of Mr. Mubarak as a cornerstone of the prevailing unjust yet stable order in the Middle East would show that this analysis is faulty and inadequate, and we believe that the region will remain in focus for much of this year.

Husni Mubarak has authorized his newly appointed vice-president Omar Suleiman to negotiate with the leaders of the opposition today, even as protestors prepare for a one million man march on the capital city, Cairo. He also replaced his interior minister one day after appointing him in order to placate the demonstrators. The military is reported to have made it clear that it will not use force, recognizing the legitimacy of the protests. Meanwhile, the stock market and banks remain closed, both S&P and Moody`s have reduced the country`s credit rating to speculative grade, and international companies are reported to be evacuating their staff. Speculation is rife that the Suez Canal may have to be closed in consequence of the turmoil, and Brent crude has already hit the $100 mark.   

In Asia, the focus is still on Chinese tightening, but recent PMI data could perhaps slightly delay the interest rate rises that the PBOC is planning. The events in Egypt and the Middle East must be watched with attention by Chinese authorities, and while there is no indication yet that similar events will be replicated in China any time soon, it is probable that if the PBOC loses its control over inflation the effect on popular sentiment will be very unpredictable. This, and similar concerns related to cost of living, and popular sentiment will almost certainly keep the Chinese on track to tighten considerably this year barring a sharp deterioration in growth numbers.

The USDCNY has remained at essentially where it was since Hu JinTao`s visit to Washington.  Today, on the back of generally stronger risk sentiment, the currency has made some gains against the USD, but we doubt that the PBOC will allow a significant appreciation in the middle of so many uncertainties surrounding the outlook. Today`s manufacturing PMI came at 52.9 for January vs. 53.9 in December, the employment component slid to 49, indicating slight contraction, but input prices were still higher at 69.3 vs. 66.7. Clearly price pressures remain intense, and with money supply growth way above the targeted 16%, the government has a lot more to do if it wants to prevent inflation getting out of control.

A total yuan gain of about 3-6% probably remains the goal of Chinese authorities for this year. USDCNY was set at 6.5860 today by the PBOC vs. 6.5891 on Monday.

In Europe, most are focusing on strong inflation numbers, and the recently hawkish statements coming from the ECB chief, and other members of governing council. It remains unclear how serious the ECB is about going ahead with rate rises, but inflation and credibility concerns may force their hands. We tend to view any series of ECB rate hikes as an indication that the end of the recent rate increases around the world has come to an end, because we do not think that the global asset bubbles would be able to withstand such a shift in sentiment.

Until the Egyptian turmoil comes to an end, the focus will be on commodity prices, and a possible widening of unrest to a wider region in the Middle East. As many would recall, Iran has had its share of violent clashes and protests only recently, and nations all along the North African coast are ripe for change after decades of brutal, and corrupt rule by dictators. We`ll continue to monitor developments and update you as events proceed.