Bloodshed for emerging market debt, Latin America and Russia see big sell off

By Reshmi Basu and Paul A. Harris

New York, April 28 - Emerging markets debt hemorrhaged Wednesday as investors reduced their exposure in Latin America and Russia.

"Emerging markets overall have been getting beaten up. But Brazil and Russia have been leading the way," said a senior sell-side official.

The JP Morgan EMBI Index was down 1.75% by the close of Wednesday's session. Its spread to Treasuries widened 14 basis points.

"We hear that everything's getting crushed and the hedge funds are running for the door," one market source added. "There's nowhere for the bonds to go.

"Latin America is the focus of the selling, more than any other sector. Asia is not being that hard hit," said the senior sell-side official. "And in Eastern Europe it's really Russia."

In late afternoon, Brazil's bond due 2040 was down over four points at 91.75 bid, 92 offered. The senior sell-side source said that the bond had been down even more in the day.

And the Russian component of the JP Morgan EMBI index was down 2.75 points in the late afternoon.

The Russia step-up bond due 2030 was bid at 91.125, 91.375 offered.

Latin American, Russian spreads widen

"On a two-day basis, if you looked at yesterday [Tuesday] and today [Wednesday], Brazil is wider by 67 bps," said the senior sell-side source in late afternoon.

"Russia is wider by 32 bps. Peru is wider by 46 bps. Colombia is wider by 33 bps. Venezuela is wider by 35 bps. (That's not quite so bad.)"

Meanwhile, Peru widened by 12 basis points during Wednesday's session.

"But it was wider by 33 bps yesterday," said the senior sell side source.

"Peru widened even more than Brazil yesterday. That Peru deal was just too big."

Peru sold a $500 million 14-year deal Monday that priced at 395 basis points over Treasuries.

No news driving plunge

While investors are positioning themselves to absorb the shocks of an inevitable interest rate hike by the Federal Reserve, there was no visible catalyst to explain Wednesday's bloodshed.

"There isn't really any news, other than the news that there are more sellers than buyers," said the sell-side source.

"The rumor was that there was one big seller in the market this morning, even before New York opened," said the senior sell-side official.

"The underlying fear factor is that people are concerned about the Fed and how emerging markets performs in a Fed-tightening scenario.

"But there has not been anything over the past two days that has really moved people. You had Treasuries take a leg down this afternoon.

"But what we've seen Tuesday and now on Wednesday I don't think is Treasury-driven," the senior sell-side source added.

"You have equities off as well, so it has not been a good day."

VimpelCom, Kaltim Prima deals may wait

The poor market performance this week prompted talk that at least two of the upcoming new deals may be delayed.

Structure is yet to be heard on VimpelCom's $300 million five- to seven-year notes.

The Moscow-based communications company is finishing roadshows this Thursday.

"But if the market stays the way it is right now I don't think it gets priced Friday. I think they would wait," said the senior sell-side source.

"Russia's on holiday next week so they might wait until after that."

Credit Suisse First Boston and JP Morgan are bookrunners on the Rule 144A/Regulation S offering.

Meanwhile, Indonesia's Kaltim Prima Coal's $375 million two-tranche deal may also be pushed back.

"The Indonesian bonds have been pretty hard hit too. I wouldn't hold my breath for Kaltim if this continues," said the senior sell-side source.

Credit Suisse First Boston and JP Morgan are also running the books for the Rule 144A/Regulation S deal.

"Sentiment in equities as well as in bonds hasn't helped. But I think EM was ahead of those markets in turning down."

Reopenings may become a trend

Nonetheless, there was talk in the emerging markets debt world Wednesday that the recent reopenings of new deals may signal a trend.

On Tuesday, the Philippines brought add ons to two of its outstanding issues while Jamaica also tapped an deal.

"I don't think it's a coincidence," said an emerging market analyst.

"There's not a lot of appetite for large new benchmark issues right now, so it makes sense to raise cash by reopening existing bonds.

"I think the Gazprom and Peru experiences - they both issued new bonds and both of them sold off after they were placed - shows that it's best to play it safe and stick to relatively minor re-openings," he added.

"I'm not sure that the Peru deal that came out was such a pick. People might be scared of buying into a new deal," said Steve Hope, managing partner of Outrider Management.

"It might be the easiest way to access the markets right now is to just tap a previous deal and bring it out ¾ of a point cheap and get people excited about buying debt cheap toward where the market has been pricing at.

"By handing them that money, it makes it a little bit easier and makes people less nervous than actually bringing out a benchmark-size new deal somewhere new on the curve where it's going to be difficult for them to clearly create value for the new buyers," he added.

Go short, suggests Hope

And one investor who is reducing his exposure in Latin American is Hope.

"The IMF report recently did a good job of stating the case. Emerging market bonds have rallied out of all proportions to any underlying fiscal improvements in the countries," Hope said.

"As U.S. interest rates unwind their big rally of the last two years, it is likely that emerging markets will retrace most of their gains in the last two years."

Another recommendation he makes is to short the market.

"I'm trying to get pretty short duration - i.e. actually shorting. I have a net negative duration in the portfolio right now. And I don't think I've necessarily completed that process," said Hope.

Furthermore, Hope believes the market has not priced in the foreseeable Fed rate rise.

"I think that anyone who thinks the market has priced in the Fed rate hikes in the coming months is likely to be wrong. History is not on their side.

"Over the first six to 12 months after the Fed's first tightening, I would be surprised if the 10s and 30s have rallied in the Greenspan era," he adds.

"It's very hard to believe that you are well served to be long in any medium to longer dated emerging market assets if the Fed starts raising rates," adds Hope.

"I'm watching the Treasury markets more closely than I have in the last three years."

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