EMERGING MARKETS-Stocks drop 2 pct, Egypt shares fall before army deadline

LONDON, July 3 Wed Jul 3, 2013 5:39am EDT

LONDON, July 3 (Reuters) - Emerging stocks dropped 2 percent on Wednesday on worries about Chinese growth and an end to U.S. monetary stimulus. Egyptian stocks also fell before an army deadline for the country's president to agree a power-sharing deal with his rivals.

Emerging markets have recouped some losses in recent days after weeks of falling prices on concern about an end to the U.S. liquidity that has boosted riskier assets.

But nervousness is increasing ahead of a U.S. holiday on Thursday and key U.S. employment data on Friday.

Chinese stocks fell more than half a percent and other Asian stocks dropped after data showing growth in China's services and consumer sectors remained modest in June.

The MSCI emerging stocks index hit six-day lows, with Russian stocks dropping 1.5 percent despite a rally in oil.

Brazilian stocks fell more than 4 percent to four-year lows on Tuesday, their biggest one-day drop in nearly two years, after industrial output data fell twice as much as expected in May.

"A lot of longer-term (emerging market) investors are just realising that they are in an asset class that has underperformed U.S. equities by 50 percent in recent years," said John Paul Smith, head of emerging market equity strategy at Deutsche.

"The structural underpinnings are disintegrating before their eyes."

Emerging sovereign debt spreads widened 6 basis points to 347 bps, but remain nearly 50 bps narrower than a week ago, enabling Nigeria to issue a $1 billion bond on Tuesday.

Egyptian stocks fell 1.7 percent at the open and the pound traded at record lows before a 1500 GMT deadline set by the head of Egypt's armed forces for President Mohamed Mursi to agree a power-sharing deal. The central bank has told banks to close their branches three hours early.

Illiquid Egyptian five-year credit default swaps eased 3 basis points to 875 bps, according to Markit, after hitting record highs above 900 bps on Monday.

Egyptian dollar bonds have posted negative returns of 19 percent this year on JP Morgan's emerging sovereign bond index .

Emad Mostaque at Noah Capital Markets recommended going neutral on Egyptian equity exposure.

"The Egyptian pound could be in very short supply again soon and the pound will likely devalue," he said in a note.

The zloty was steady before an expected Polish rate cut.

Turkish stocks and the lira fell after higher-than-expected inflation data.