While the MSCI Index has advanced more than 40 percent this year – far outpacing developed countries – and the EMBI+ has returned 13 percent, analysts believe that the “green shoots” are widely expected to wither globally.  Heading into the anniversary of Lehman’s collapse, most debt and equity analysts are anticipating further trouble; potentially from European bank losses transmitted both from developed and emerging market defaults, foreign exchange market turbulence on heavy government borrowing, and/or poorer than expected macro-economic or developed country bank data releases.

For emerging market-specific issues, the biggest concern is the potential for a Latvian devaluation, which analysts widely believe will impact all of Europe despite the country’s small size. Even with the EU’s recent funds release, analysts believe that a is almost inevitable.  They believe that if and when the regime is dismantled, it is likely to result in a ripple effect across the Baltic States due to the massive trade linkages between the three, with a shift in foreign exchange regimes expected in Latvia’s neighbors as well to maintain competitiveness. Analysts also believe that a devaluation in the Baltic States is likely to pressure Bulgaria’s peg, and result in further depreciation of other regional currencies, notably Romania and Hungary. In addition, Russia remains a source of significant concern, particularly after President Medvedev publicly stated at a major economic forum that a second wave of the crisis is expected to hit.  While the rebound in global commodity prices is seen as a boost for Russia and its CIS neighbors – as well as for other significant producers – it is seen as inadequate to stave off the expected wave of corporate defaults and bank bankruptcies as the Kremlin has backed away from its original pledge of corporate support.

Analysts indicated that the recent rally in emerging market stocks and bonds does not reflect the real economy, and they do not believe that the markets are able to truly “de-couple,” a theory again being advanced in the press.  While some argue that domestic demand in some markets – notably Brazil, China, and India – will spur better than expected performance this year, most believe that global stabilization and nascent recovery has not started and that recent strong rallies have been fueled by low interest rate liquidity coupled with a modest pick-up in risk appetite

They are particularly skeptical of the massive narrowing of spreads in the corporate bond segment as most emerging markets borrowers still lack access to fresh foreign exchange to service upcoming obligations and they expect defaults to rise through the rest of the year.  Already there have been at least 15 defaults – with an estimated dozen standstills at the moment – totaling  USD 13.2 billion, according to industry sources.

Globally analysts widely expect turmoil to ease during the summer, but re-intensify in the fall.  Latvia’s July access to EU funding averted a “worst case” scenario there for a couple of months, with devaluation expectations – and the broader European-wide implications – to again top analysts’ agendas.  While the IMF is touting its new flexibility – and analysts have welcomed access for Colombia, Poland and Mexico to the new flexible credit line – analysts are warily watching to what extent it will allow fiscal slippage before possibly imposing conditions on the pre-approved arrangements.  For example, in the days after the IMF/EU allowed Hungary to widen its budget deficit target for the year, investors sold local bonds as deficits remain key decision-making factors. 

In this context, and following previous adjustments for the larger Ukraine program, Latvia’s direction will mark a broader precedent for IMF lines as a linchpin of anti-crisis strategy and for continued European parent bank backing of local units should actual and likely losses mount. Europe’s predicament, with parallels to the previous Latin debt and Asian financial crises as well as its own early 1990s EMU unraveling, remains a pervasive regional obstacle as the universe is again experiencing uniform commodity, currency, bond and stock upswings in a pendulum shift to the extreme pessimism of late 2008/early 2009. The moves have been indiscriminate at opposite ends, and over the coming months, especially as large foreign debt repayments come due, syndicated lending shows scant signs of healing.  At the same time, as fiscal policy costs start to raise both developing and industrial world interest rates, a more straightforward balance will materialize which can envision asset class gains as funds redeploy from safe haven US dollars and money market funds, but cannot be justified across-the-board on underlying economic and earning criteria.