Emerging market softer on external factors; investors eye Friday's U.S. job data

By Reshmi Basu and Paul A. Harris

New York, Aug.3 - The dog days of summers had a cooling effect on emerging market debt Tuesday as players took off for summer.

"It's been very, very quiet," said a buy-side source. "August is a very quiet month. Everybody is on vacation.

"Small buying here and there," the source added, summarizing the day's trading.

Overall, the JP Morgan EMBI Index rose 0.04% during Tuesday's session. Its spread to Treasuries tightened three basis points to 465 basis points.

Tuesday's market's softness can be attributed to a combination of factors which are resulting in investor uncertainty, such as the reports on the U.S. economy, the terror alert in New York, events in the Middle East and high oil prices, according to a debt strategist at Refco EM.

Those drivers coupled with the summer lull have resulted in the lack of trading activity this week.

The high price of oil "has taken a little bit of the momentum that emerging markets had during the past days," said the strategist.

"And we see that today [Tuesday]. Brazil is flat to a little bit higher. Colombia outperformed on the longer part of the curve. Mexico is a little bit higher," he observed.

During Tuesday's session, the Brazil C bond was rose 0.062 to 94.312 bid while the bond due 2040 was unchanged at 98.10 bid.

Mexico's bond due 2026 gained half a point to 143 bid.

External factors creating investor uncertainty

Since Monday, external forces have moved emerging market debt and Wednesday's trading will be no exception, predicting the Refco EM strategist.

Trading is expected to be sluggish for the rest of the week, as investors await a slew of macroeconomic data, including Friday's vital non-farm payrolls and unemployment data.

On Tuesday, the release of U.S. consumer spending hinted that the economic rebound is sluggish.

In the biggest drop since September 2001, personal spending fell 0.7% in June after rising 1% in May.

"The numbers on Friday are going to indicate the creation of employment in the U.S. economy, said the strategist.

Over the last three months, those numbers have created a lot of uncertainty in the market.

"Friday's numbers will let us know with a certain degree of assurance that the Fed will increase the interest rates by 25 basis points, he said.

"Overall, the market is expecting that, although the numbers have not been very strong in the past couple of days.

"The market still thinks that interest rates will be higher by 25 basis points, and that will create some pressure on emerging markets overall," he added.

And while bad news for the U.S. markets tends to have a positive effect for emerging markets, negative stories are producing investor uncertainty.

"Unfortunately, this time is a little bit different because we are talking about the uncertainty created by a potential terrorist event - and that is a negative for all the markets," he said.

Although the price of oil has positive repercussions for petroleum producers such as Mexico, Russia, Ecuador and Venezuela, the prices are at such a high level that emerging market countries that are importers will suffer in the long run, noted the strategist.

Oil hits $44.15

Overall, emerging markets credits that are oil exporters have benefited from the spike in oil prices, although the effect has been minimal, according to the buy-side source.

"You would think exporters like Russia and Mexico would do better.

"I think at least in Russia, the whole Yukos thing is more of an effect than oil prices," added the source.

Russian authorities are taking another look at Yukos' 2001 tax payments, which could result in a larger tax bill for the embattled oil producer. The company continues its standoff with the government over a crippling $3.4 billion tax bill from 2000.

"And for the countries that are importers, we have not seen a negative effect yet," the source said.

"There are some comments here and there mentioning how high oil prices can affect inflation in those countries, but there is no reaction in spreads."

Oil prices climbed above $44 a barrel Tuesday, surpassing Monday's record of $43.82.

But in general, the positive effects on producing credits have been relatively minimal.

High oil prices have been priced in, but not at this high level, according to the source.

If oil prices stay this high, eventually there will be a reaction, said the source.

Slight sell-off in Ukraine

The International Monetary Fund failed to complete the review of Ukraine's performance under the precautionary stand-by agreement, placing downward pressure on its paper.

The IMF expressed concern over the Ukraine's national budget deficit.

"The review under the SBA cannot be completed because of slippages relating to fiscal policy, structural measures in the fiscal and banking areas, as well as the accumulation of new VAT refund arrears," the IMF said in a statement.

Ukraine government officials said the country does not have a real national budget deficit.

"Bonds sold off a little bit, but nothing major," said the buy-side source.

Wait and see mode until Aug. 10

Investors are engaged in the wait and see mode until the Federal Open Market Committee's next monetary policy-setting meeting on Aug. 10.

"Aug. 10 will be the day when the market realizes that the Fed will increase interest rates," said the strategist.

"And hopefully, the market adjusts prices to that event.

"From then, we will be watching individual countries and local markets to see what's the next driver.

"And nothing external besides high oil prices will influence this market," he added.

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