Libya to push up oil, cool risk appetite

NEW YORK/LONDON Sun Mar 20, 2011 5:34pm EDT

A rebel fighter looks at burning vehicles belonging to forces loyal to Libyan leader Muammar Gaddafi after an air strike by coalition forces along a road between Benghazi and Ajdabiyah March 20, 2011. REUTERS/Goran Tomasevic

A rebel fighter looks at burning vehicles belonging to forces loyal to Libyan leader Muammar Gaddafi after an air strike by coalition forces along a road between Benghazi and Ajdabiyah March 20, 2011.

Credit: Reuters/Goran Tomasevic

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NEW YORK/LONDON (Reuters) - Investors already bruised by the Japan disaster now confront military air strikes on Libya and the prospect of rising oil prices, making it likely they will postpone any bold investment decisions.

Until a clearer picture emerges, they will want to steer clear of riskier assets as they recalibrate positions.

One thing seems certain: Oil prices will renew their advance posing a new challenge for global recovery. Some analysts said benchmark Brent crude could surge $5 toward the recent two-and-a-half year peak of $119.79, after closing Friday at $113.93 a barrel.

Western forces pounded Libya's air defenses over the weekend to repel Libyan leader Muammar Gaddafi from rebel strongholds as they enforced a U.N. Resolution. The attacks are set to continue in coming days. Analysts said the strikes create fresh uncertainty.

"It's an open-ended question because we don't know whether the air strike on Libya will turn into a quagmire or a quick victory,' said Boris Schlossberg, a currency strategist at GFT in New York.

"If the situation drags on, this will make investors pull in their horns because it creates yet another geopolitical hotpoint."

The United States said Sunday it expects to conduct more air strikes on Libya as part of enforcing a U.N. resolution.

As the Japanese nuclear crisis unfolded last week and the death toll from the tsunami rose, investors pulled out of riskier assets pressuring global stocks, while the yen surged on the prospect of Japanese investors bringing their money home.

Oil already had advanced last week and further gains could threaten to manacle future global economic growth. It is enough to make some longer-term investors freeze, or at least sit on the sidelines and not make major moves.

"The situation is too fluid and too uncertain to warrant changes," Joost van Leenders, strategist at BNP Paribas Investment Partners, said in a note to clients.

Equity market losses since the earthquake in Japan have been around 2 percent, as measured by the MSCI World Index. In Tokyo losses were worse., falling 10 percent. Volatility has risen, but is still far from where it was during the height of the euro-zone debt crisis.

Aside from Libya, Bahrain is also in focus, having cracked down on mainly Shi'ite Muslim protesters, a move that has angered Iran and raised tensions in the oil-exporting region. In Yemen, the president sacked the cabinet after deadly protests. Unrest shook Syria on Sunday and Saudis gathered to demand the release of prisoners.

OIL, JAPAN ARE KEY

The heart of the uncertainty for investors is what rising oil prices and Japan's earthquake, tsunami and nuclear breakdown will mean for the world economy and financial markets.

The initial reaction to Japan was that the global economy would cope quite well, seeing only 0.2 percent or so trimmed from global growth that was running above trend around 4.4 percent.

But the nuclear crisis and the potential for Japanese investors to pull money back from world markets -- or at least not put more in - has raised concerns about the impact on markets even if Japan does manage a V-shaped recovery.

"The direct or first round economic effects of the tsunami are likely to be relatively contained to Japan, but the financial market spillovers could have very serious global repercussions," Fathom Consulting said.

Friday's Group of Seven coordinated intervention into foreign exchange markets to cool the yen was the most vivid example to date. The yen had been soaring, driven either by money being repatriated or positioning for it to be.

Traders are expecting more intervention in the coming week.

Investors were also becoming more cautious before the earthquake, partly as a result of the spike in oil. Some see the disasters in Japan as confirming that trend.

"This is a catalyst for a fairly large shake out," said Graham Neilson, chief investment strategist at Cairn Capital, referring to risk assets as a whole.

MORE TESTS AHEAD

Investors, in the meantime, will get a snapshot of how higher oil prices are playing into various sectors of the world economy over the coming week.

Euro zone PMI manufacturing and services flash estimates on Thursday, for example, will show whether oil prices have led to a dent in sentiment.

The split nature of the U.S. economy should also be on view, with potentially weak housing data expected Monday and Tuesday but good durable goods orders Thursday.

At the end of the week, the EU summit is set to rubber-stamp an already agreed but surprisingly strong package of euro zone crisis measures.

But the euro zone's highly indebted members have enjoyed little respite from market pressure since the package was unveiled, with Portugal facing ever rising borrowing costs.

Bond investors will be looking for clarity on the welter of conditions attached to the plan for the EFSF to buy bonds from the primary market and the timetable for implementation.

And any sign of delays in implementation or watering down of the final deal risks triggering a fresh sell-off which might well sweep across the euro zone periphery.

(Additional reporting by Jeremy Gaunt. Editing by Stella Dawson)

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