Emerging market debt higher in volatile session; value seen in Venezuela

By Reshmi Basu and Paul A. Harris

New York, Aug. 10 - Emerging market debt market moved higher Wednesday, but cooled off at the end of the session.

"It was well bid for most of the day, following last night's strong close after the Fed," said a trader.

On Tuesday, the Federal Open Market Committee raised the federal funds rate by an expected quarter percentage point to 3½%, which prompted a U.S. Treasuries rebound.

That positive sentiment fueled emerging market debt for the second part of Tuesday's session and carried over into Wednesday.

The market had a strong opening, but saw some volatility on thin trading volumes, said sources.

The trader added that the market closed off the highs it hit during trading Wednesday, coming under pressure from a downturn in U.S. financial markets.

"The Brazil '40 traded at a high today [Wednesday] of 119¾ bid. It traded down to 119.20, about 50 cents off the high," he remarked.

"In general, tone isn't that great. We were fine this morning. Then as equity markets kind of turned south and so did Treasuries, EM kind of turned."

Record high oil prices took a bite out of the U.S. equities market. The market saw its gains erased as oil prices climbed to a record $65 a barrel.

At the market close, the Dow Jones Industrial Average was down 0.2% to 10,594.49. At one point, the market was up by as much as 100 points to 10,719.41.

However, the late session sell-off may be a result of profit taking, according to a Latin American debt strategist for Refco EM.

"It was a strong rally," said the strategist.

Strength in Latin America

The strategist added that the Latin American region is seeing strength, as president Luiz Inacio Lula da Silva looks to be insulated from the ongoing bribes for vote scandal. Also adding support is positive macroeconomic data in the region as well as the view that the U.S. economy is heading towards more volatility.

And the perception of a flat U.S. Treasury yield curve is also helping the region, given that the 10-year yield is at 4.40% and the two-yield is at 4.11%.

"I think we've seen the strength of the region as a whole. Currencies are strong. Balance of payments are improving. Current accounts are also improving," noted the strategist.

"We were counting on Brazil, once it was able to move away from the scandal, that it would be the country to lead the rally and I think we've seen that today [Wednesday]."

At the end of the session, the Brazil bond due 2040 was bid at 1191/4, up three-quarters of a point, said a market source. The Colombia bond due 2012 gained 0.20 to 115.90 bid. The Mexico bond due 2009 lost 0.35 to 117.55 bid.

The trader noted that as volume thins out over the next two days, trading may become increasingly choppy. Also, there are no major economic releases in the United States due this week to give the market a push.

"I don't we're go too far one way or the other," added the trader.

Value in Venezuela

It has become quite an ordeal for investors to find value, as spreads remain so tight. In a sign of the narrowness, the JP Morgan EMBI+ Index compressed by six basis points to 274 basis points more than Treasuries in Wednesday's activity.

Venezuela may be the only credit out there with any value, according to Christian Stracke, emerging market analyst for research firm CreditSights.

"The market consistently overstates the political risks in Venezuela, in my view, and with Venezuela still trading 40 bps wide to Brazil at the long end of the curve, investors get a comparatively high reward for taking that political risk.

"Venezuela has none of the short-term, or even medium-term, fiscal and balance of payments risks that Brazil, Turkey, Colombia, or the Philippines all face, assuming oil prices remain north of $40/bbl or so," he said.

Meanwhile, the Refco strategist said that the Venezuela story means that investors are balancing the potential political risk against the strong price of oil.

"I have been a buyer of Venezuela in the past year. As long as oil continues to leave large amounts of money in the hands of the government and the government is able to meet its international obligations, there shouldn't be a reason why the bonds will not perform well," he remarked.

Furthermore, the government will meet its budgetary obligations if oil is within the $24 to $27 per barrel range, he noted. With prices close to $60 per barrel, Venezuela is enjoying a revenue windfall.

"The long-term outlook is not especially rosy in Venezuela, but you could make the same argument for many other EM credits, all of which are trading at a considerably lower spread than Venezuela," added Stracke.

During the session, the Venezuela bond due 2027 added 0.40 to 105¼ bid.

Ecuador's new finance minister

Last week finance minister Rafael Correa resigned, sending Ecuador's bond prices down. Deputy finance minister Magdalena Barreiro was sworn in as his replacement on Monday.

Former minister Correa and president Alfredo Palacios clashed over economic policy and a Venezuelan loan deal. Correa wanted increased social spending from oil revenues as well as a $300 million bond sale to Venezuela in order to decrease its dependency on multilaterals.

He said he was forced out because of pressure not to go ahead with the Venezuelan deal.

The strategist said that the market sees his replacement as a positive. But he noted that this situation highlights how difficult it is to promote a position in Ecuador.

Ecuador's relationship with the World Bank and International Monetary Fund have been under increasing stress over the country's plans to get rid of an oil revenue fund earmarked for debt payments.

"Due to the criticism that the minister [Correa] made to the multilaterals, there was a confrontation within the government. That's not unusual at all in Ecuador," commented the strategist.

"The replacement gives some continuity to the previous association with Venezuela," said the strategist.

"The market is really looking at that, just because it will provide the country with enough liquidity to meet its obligations this year."

The market is concerned as to how the oil money will be spent, whether the country will retire debt or use it for social spending.

"It's really hard to tell what is going to happen," he said.

"Either way, the social approach... has not achieved the political support. The market goes back and forth. And I think it's going to remain like this, but I still think there's some value in Ecuador."

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