Emerging market paper down on profit taking; Brazil softer on Treasuries, dip in Lula's approval

By Reshmi Basu and Paul A. Harris

New York, June 22 - Monday's emerging market rally ended as investors engaged in profit taking in thin trading during Tuesday's session.

"It was a pretty slow day," said a trader in late afternoon.

"We saw a lot of activity in the morning, mostly around this new issue [Brazil's bond] and then things sort of got very quiet."

Generally emerging market debt traded lower. The JP Morgan EMBI Global Index fell 0.12%. Its spread to Treasuries tightened by three basis points to 470 basis points.

On Monday morning, the market rallied on the Brazilian government's announcement of an initial $500 million sovereign deal - subsequently upsized to $750 million.

"You can say that the market reaction to that was surprising because usually the market is expected to sell off when a new issue comes," said a buy-side source.

"The reaction was just the opposite with this one because it was a smaller size."

Brazil's first foray into the capital markets in almost 10 years came as no surprise since the country must issue $2.5 billion in 2004 to plug its foreign debt.

"Everyone knew that Brazil would have to issue at some point. The fact is that it was a fairly small issue," added the buy-side source.

"It was a floating-rate note that everyone wanted.

"It gave a signal to the market that they've done what they needed, so the reaction was actually positive."

The Federative Republic of Brazil priced its upsized $750 million of five-year floating-rate bonds (B2/B+) at 99.245 to yield three-month Libor plus 593 basis points via Merrill Lynch & Co. and Goldman Sachs & Co.

During Tuesday's trading, the new floater traded as high as 99.80 and was seen a little lower by late afternoon at 99.20 bid, 99.30 offered, said a trader.

"Brazil was trading well in the morning and fell with Treasuries and the bond market is feeling the effects," added the trader, noting the long bond was down 14/32.

Lula's ratings slump

Also helping curtail the rally from Monday was a drop in the approval ratings of Brazilian president Luiz Inacio Lula da Silva.

Lula's embattled presidency faced more bad news as his standing among voters slipped to an all-time low, a drop attributed to the country's high unemployment rate.

The approval rating of Lula's government dropped to 29.4% from 34.6% in May, according to Instituto Sensus. His personal popularity rating slipped to 54.1% from 60.2% in May.

"That has the same effect on the market," said the buy-side source. "People decided it was time to take profits. I don't think they see a lot of upside from here."

During Tuesday's session, the Brazilian bond due 2040 was down 0.40 to 92.6 bid, 93.10 offered. The benchmark C-bond fell 0.13 to 90¾ bid, 90.812 offered.

The Brazilian component of the EMBI Global Index was down 0.35%. Its spread to Treasuries was unchanged to 647 basis points.

China's crowded field

In primary action, another Chinese bank added to the pipeline. State-owned Chinese Development Bank is expected to issue $500 million to $1 billion notes.

CDB joins state-owned Export Import Bank of China (Chexim), which plans to issue $1 billion 10-year global bonds (foreign currency rating A2/BBB+) in July via Citigroup, Goldman Sachs & Co. and HSBC.

Also expected to issue is the Hong Kong-based division of Industrial Commercial Bank of China with $300 million of bonds due 2009 via Goldman Sachs & Co., HSBC Bank and JP Morgan.

With the recent wave of Chinese banks hitting the market, the issuers may have lost the home turf advantage.

"When we first heard about Chexim, the deal sounded like it could benefit from the rarity value of Chinese paper," said an emerging market analyst.

"But now that CDB is also talking about their own $1 billion issue the rarity value has all but disappeared.

"In general, the Chinese banks are trying to do what every other EM issuer is now trying to do - come to the market with a new deal before the current window of opportunity closes," he added.

"I think there's enough demand out there for both Chexim and CDB to get done but they won't be home run deals if they come to market within days of each other."

China's debt traded lower during Tuesday's session. Its component of the JP Morgan EMBI Global Index fell 0.03%. Its spread to Treasuries tightened by two basis points to 71 basis points.

Two corporates hit the road

TPSA Eurofinance SA, a financing subsidiary of Telekomunikacja Polska SA, is presently on the road with a minimum €300 million offering of seven-year bonds.

Roadshow stops are schedule for Paris on Wednesday and Frankfurt on Thursday.

BNP Paribas and Deutsche Bank are running the books.

Also, Romanian private oil company Rompetrol Group Netherlands NV will start a six-day roadshow Wednesday in Athens for €250 million of senior notes that are expected to come with a three- to seven-year maturity (/B-/B-).

JP Morgan will run the books.

Brazil's steady rates called unwise

Ed Maran, associate portfolio manager for Thornburg Investment Management, sees no reason to celebrate last week's unanimous decision on the part of Copom, the Brazil central bank's monetary policy committee, to hold the benchmark Selic rate at 16%.

"The unchanged Selic rate is not positive," Maran wrote in an email message.

"A declining Selic rate would improve growth prospects for the economy, which would improve the fiscal position of the country.

"Since the central bank knows this and did not lower the rate, it implies they fear capital flight from investors.

"The rate should decline from current levels as it is inconsistent with Brazilian inflation. It will only stay at current levels if fear of capital flight remains," added Maran.

Market weight for sovereigns, suggests BofA

Meanwhile Banc of America Securities is recommending investors hold emerging markets sovereigns at market weight, taking advantage of the rally since May 10.

Since that date, emerging market sovereign debt has performed well as global debt markets have steadied and the dollar has come off its highs, according to a report by Callum Henderson in B of A's Situation Room report.

Emerging market sovereign debt benchmarks have rebounded 6.41% since May 10, partly fueled by market technicals.

Some Latin American high-beta countries have outperformed. Brazil is up 9.25% and Ecuador rose 18.29%.

According to the report, there's even talk of Turkey coming back to the capital markets. But the question is whether an improved investor appetite will be able to swallow Federal Reserve tightening and more issuance.

Medium-term economic fundamentals are stronger this time around then during previous Fed tightening cycles, according to Henderson. All three regions have strengthened their current account balances and foreign exchange reserves. Budget deficits have been reduced and emerging market economies are rebounding.

But Brazil and Turkey are highly vulnerable to higher interest rates, given their debt.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.