Emerging market debt up on lower-than-expected job numbers; Brazil reopens its 2014s

By Reshmi Basu and Paul A. Harris

New York, Dec. 3 - Emerging market debt moved higher Friday on weaker-than expected U.S. job data. Also making headlines, Brazil reopened its 10½% bonds due 2014 to raise $500 million, cashing in on the current rally.

U.S Treasuries perked up on the sluggish job growth data. The Labor of Department reported the creation of 112,000 non-farm payroll jobs, well below Wall Street's forecast of 180,000 to 200,000.

"It's clearly good news for bond prices," said Steve M. Hope, managing partner of Outrider Management.

"Any spread product is going to have a good day because Treasuries are having a good day. If I look at the 30-year [Treasury] futures, they are up nearly two points.

Ending the recent bearish run, the yield on the 10-year U.S Treasury note stood at 4.27% at Friday's close, down from 4.41% at Thursday's close.

Despite a gain in returns, emerging market spreads did widen, observed Hope.

"If I look at Brazil '40s, they are nearly up two points," he said.

But in the early afternoon, the spread for the bond due 2040 was one basis point wider and the C bond spread moved out by nine basis points.

"If I look at emerging markets in general, they are generally wider rather than tighter. It's [the job numbers] good for emerging market bonds because it's good for all bonds," he added.

The JP Morgan EMBI+ Index gained 0.55% on the day while its spread to Treasuries widened by four basis points to 376 basis points.

"The whole market has been rallying. Not everyone is rallying according to the rally in Treasuries, but the tone is positive," said a market source.

Brazilian paper was up. The Brazil C bond added a quarter of a point to 101 bid while its spread widened five basis points to 401 basis points. The bond due 2040 added 1.35 to 115¾ bid. It tightened two basis points versus Treasuries to 446 basis points.

The Mexico bond due 2009 was up half a point to 122.40 bid. The Russia bond due 2030 gained 0.938 to 101 bid. And the Venezuela bond due 2025 was bid at 103¼ bid, up 0.65.

Brazil reopens 2014

The ongoing rumors that Brazil would tap the market finally came true Friday. The Republic of Brazil reopened its bonds due 2014 to raise $500 million via Morgan Stanley and JP Morgan.

The bonds priced at 114.75 to yield 8.244% or 398 basis points more than Treasuries.

Normally the bonds wouldn't be placed on a Friday, but the payroll numbers made it a timely deal, said the market source.

"The real has been outperforming every currency," said the market source.

"They reopened the bonds because there was a rally in the Treasuries, which meant for them lower rates."

It was a good deal for Brazil, given that it lowered costs, he added.

"They have been rallying the last half of the year. This is relatively cheap funding for them. They are tapping already existing bond, so that it makes it less risky."

Just maybe the Brazilian deal will lure other issuers to come to market in December because it shows there is some demand for new paper, he noted.

"But again some of them will wait till January."

And he is not surprised that so much of 2005's financing has already been completed by emerging markets issuers.

"The thing is that rates being are so low, it makes all the sense in the world for issuers to come to the market because the perspective is for rates to increase next year."

Cautious on EM, says Hope

Friday's job report signaled to the U.S. Treasury market that the Fed might not be in such a hurry to tighten monetary policy. But according to Outrider's Hope, the job data offers little insight, as an onslaught of higher rates is inevitable.

"I don't think today's [Friday's] numbers changes the big picture much at all," said Hope.

The reason to buy bonds on Friday was either you believe that the Fed's policy will change over the next 18 months or your view on longer term inflation has changed, observed Hope.

"Honestly, one low payroll number doesn't really discount things as much. I actually thought today [Friday] would be a day we would see a big rally in the bonds and then see a sell-off as people said that it doesn't change the fact that rates are going to be rising.

"I'm a bit surprised by this follow-on strength of this rally. I still would guess that the 10-year in three months would be closer to 4¾% than 4%. I would say most of Friday's rally is mistaken," he commented.

"And all the emerging market activity just follows on from that. Emerging markets are visibly not even higher beta than the Treasury market these days in terms of how they react to these kinds of numbers.

"But I don't think there is anything about emerging market spreads you can read into a weaker payroll numbers," he commented.

Building more cash, says Hope

In terms of his portfolio, Hope is short duration and is building up even more cash.

The last paper he sold were bonds from Ukraine, about a month and a half ago.

"I own three sovereign bonds - long positions that are all very exotic.

"I have four sovereign short positions that I've held for six months. I don't do a lot of trading in sovereigns," he said.

He has also reduced his corporate exposure.

"Corporate bond spreads have probably outperformed sovereigns over the last several months with good reason. Having said that, I'm not sure that I can pay for the risk at this point.

"I do think that rising rates at some point lead to rising spreads. If you are getting a 9% yield on something with five duration but you think it might move a percent it doesn't pay you in terms of yield over the next six months."

Hope is also not in a buying mood because the math just does not add up as interest rates are on the rise.

"I think if the 10-year is going to be at 4¾% in three to six months, you aren't going to make anything in coupons over the next six months that will compensate you for the capital loss.

"If you just take 4¾% for a starting point from six months from now, you are going to make 2¼ points on your carry. From your coupon, you are going to lose three points of capital versus being in cash, which is paying you 2%. So you will make a point over that time, you are losing nearly two points.

"I guess you would break even somewhere around 4½% in six months. If you think that the Fed might raise rates over those six months three times, you would be 2¾% on the [fed] funds.

"That's a pretty flat yield curve. Again, I think that people who are buying have it wrong," he argued.

And Outrider's Hope is a little more suspicious of Brazil, where he is short duration.

Brazil is maybe on the threshold of getting to a stage where it has actually established enough credibility in the financial market to receive it gets the benefits of fiscal rigor.

"They may actually be getting to a stage where they will trade more like Russia than like Venezuela. That is a meaningful progression and they have sacrificed a lot of growth to get to this point. I think there are good reasons to be bullish about Brazil but they could run out of political will in the next 12 to 18 months because the growth numbers are just not there."

"If I had to bet one way or another, that is what I would bet would happen," he concluded.

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