Emerging market spreads tighten on Fed statement; risk to Brazil from pension case

By Reshmi Basu and Paul A. Harris

New York, June 30- Emerging market spreads tightened Wednesday as investors sighed in relief on news that the Federal Reserve would raise the target for its key interest rate by 25 basis points.

The Federal Open Market Committee reaffirmed its intentions to move rates at a "measured" pace.

"With underlying inflation still expected to be relatively low, the committee believes that policy accommodation can be removed at a pace that is likely to be measured," the FOMC said in its written statement.

"The market wants to move higher but not with a whole lot of enthusiasm," said a debt strategist at late afternoon.

He added: "There was some residual nervousness about whether the Fed would remove the 'measured' language. There was fear that the underlying Treasury market would have to reprice."

That concern surfaced Tuesday in what seemed to be some last-minute selling ahead of the decision, according to the debt strategist.

"And to the degree that any of that is short-selling, it would have to be covered today."

Concerns remain that the Fed may yet have to play catch up with rising inflation. Nonetheless in the short-term, both investors and issuers are seen embracing the Fed decision.

"The market will like it insofar as it now appears that the Fed will only raise rates slowly," said an emerging markets analyst.

"But there will still be plenty of questions about whether the Fed is now behind the curve in fighting inflation.

"After all, we've had plenty of warning signs on inflation and the Fed has only nudged rates up to 1.25%, not exactly an aggressive stance.

"But in the short term it should mean continued ample liquidity for EM, including for new issuers," he added.

Brazil firmer, Russia flat

On the Fed news, demand for Brazilian paper surged Wednesday. Its debt was seen moving progressively higher during the day with the pace accelerating following the Fed's 2:15 p.m. ET announcement.

In the early morning, the Brazilian bond due 2040 was bid at 92.8125 and the C bond was bid at 90 7/8.

At 1:15 p.m. ET, the bond due 2040 was bid slightly higher at 93.05 while the C bond was bid at 911/4.

After the Fed announcement, the bonds edged higher. The bond due 2040 was bid at 93.6 while the C bond was bid at 91.625.

In late trading, the bond due 2040 was up 2.6 to 94.2 bid and the C-bond was up ¾ to 91.875.

A trader noted that the Brazil component of JP Morgan's EMBI index was tighter by 15 basis points at the end of the day and the EMBI plus better by three basis points to close at 490 basis points.

However, trading in Russian debt was soft during Wednesday's session.

"Russia has been trading pretty much unchanged. We saw a little bit of buying in the Russian notes due 2018, but nothing really significant," said a trader.

He pointed to Russia's component of the EMBI index which was 4 basis points wider on Wednesday.

The Russian benchmark bond due 2030 was up 0.688 to 91.312 bid in late trading.

Investors are hoping that the Fed news marks the return of bidders stranded on the sidelines for what has been several days of ups and downs.

"Back in May we saw the EMBI plus in a 505 context. On June 23 it was at 481. From June 23 onward, the spread has been widening," said the trader.

"We saw a big jump on June 25, when it jumped from 483 to 493."

Sri Lanka to issue

In primary news, the government of Sri Lanka plans to issue $400 million of bonds this year to cover its budget deficit.

And a market source told Prospect News that the local press in Uruguay is reporting that the government is planning a new international bond issue of between $150 to $200 million in the next few days via Citigroup and ABN Amro.

Supreme Court is biggest threat to Brazil

Looking long term, Brazil is a positive story of strong fundamentals, according to the debt strategist.

"It's a basic building block story. We tend to believe that the world economy is going to actually be fairly strong for a couple of years.

"That strength, particularly out of Asia, benefits Brazilian exports," he said.

He expects that the Brazilian trade balance will be sufficient to produce firmer exchange rates, less inflation and maybe even an actual flow of hard currency into the economy, which could boost reserves and re-liquefy the domestic capital markets.

"The question mark has been how long can the current monetary/fiscal policy mix be maintained in the face of what has been disappointment in terms of domestic growth," he said.

Economic indicators such as the creation of 150,000 jobs monthly and the projection of 3.5% GDP this year should signal to the market that Brazil is on the right track and that bank president "Dr. [Henrique] Meirelles has got about the right dosage.

"In that case, the market will look favorably on Brazilian credits," he added.

But the story of Brazil is often the story of politics. And the greatest risk to Brazil is how its supreme court will rule on the constitutionality of taxing pensions, a measure passed by Congress to reduce the budget deficit.

"Brazil is a story of political issues. We are on the threshold of another one as the Supreme Court tries to decide whether the social security reforms are legal or not," he said.

The Supreme Court's decision could derail momentum for Brazil.

"The difficulty has been in the past, the Brazilian political process has always found ways to pull the teeth out of the jaws of victory.

"The Supreme Court has certainly been an element in that.

"The Supreme court issue is an important one. It can rain on the parade," added the debt strategist.

© 2015 Prospect News.
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