Emerging market paper softer on Brazil issuance rumors but central bank minutes prompt late rally

By Reshmi Basu

New York. Aug. 26 - Rumors of a new sovereign issue from Brazil and continued profit taking pushed down emerging market debt in thin trading Thursday - but Brazil itself ended the day higher after a late-day rally sparked by the release of minutes from the last central bank meeting.

While profit taking has placed downward pressure on the market in the last two days, rumors of a new issue from Brazil had the most impact in Thursday's session, according to a buy-side source.

"As we grind tighter and tighter, you would expect people to say that this is getting really tight here," said the buy-side source.

"And the last time we've seen this was in January, and look what happened. Today [Thursday], I would say that the Brazil news started weighing down the market and from there it dragged Latin America," added the source.

The source added that the market was mostly quiet - "really no flows" - and what activity there was was mostly from Wall Street dealers.

"The market is a bit softer today [Thursday]," said a buy-side source. "We've widened out a bit."

However, after weakening in the morning, Brazil's debt did finish the day higher.

The Central Bank said it might raise its benchmark lending rate for the first time in more than 18 months, according to the minutes releases from last week's policy meeting. The bank said current rates were not enough to curb inflation, given high oil prices and the acceleration in its domestic growth.

Also positive for Brazil, the unemployment rate, which measures joblessness in Brazil's six biggest metropolitan areas, dropped to 11.2% in July from 11.7% in June.

The Brazil C bond added 0.375 to 97 bid while the bond due 2040 was bid at 105.15, up 0.55 in light-trading. The 2040 bond had been down 0.10 at mid-day.

Looking at other specific issues, Thursday's session was a mix bag. The Russia bond 2030 was marginally lower by 0.001 to 95.187 bid. But Mexico's bond due 2026 added 0.10 to 148½ bid. The Ecuador bond due 2030 was bid at 77.45, down 0.05. The Philippines bond due 2016 fell 0.625 to 97 bid.

Overall, the JP Morgan EMBI+ fell 0.15%. Its spread to Treasuries widened five basis points to 438 basis points.

Rumors of a Brazil tap

Rumors of a seven-year sovereign issue from Brazil raised supply concerns as September looks to be an issuer-laden month.

"I guess people start thinking, what's going to happen when everyone comes back from vacation," said the buy-side source.

"Spreads are getting lower, so issuers would try to take advantage of that to come to the market," said the source.

Speculation over a new issue is becoming louder and louder as Brazil still has $1 billion of debt to sell under this year's $4 billion overseas financing plan.

"If you look at the timing and the spreads that they can get, it seems like an attractive time to do it," said the buy-side source.

"We are almost at the tights [spreads] that we had at the beginning of the year."

Furthermore, it is optimal for Brazil to take advantage of the market now, given that U.S. interest rates are on the rise, according to the source.

"You just have to look at who else has financing needs left to be covered for the year, and Brazil is one of them."

Colombia is expected to tap the market for its pre-financing needs in 2005.

"The timing is great. There is no guarantee that you are going to get these low, low levels into next year. Why not issue for whatever you have left for this year or even prefinance?"

But that supply will cause some spread widening, noted the source.

Brazil can go higher

Brazilian paper has not hit a wall, as it still has room to grow, according to an emerging market analyst.

"I think Brazil debt could certainly still move higher if all the right pieces of the puzzle are in place: U.S rates remain low, oil prices continue to fall, the reform agenda stays on track in congress, and the supply of new EM issues doesn't go too high," said an emerging market analyst.

"I think that's a lot to ask, though, especially because the pipeline of new deals likely to hit the market in September looks pretty sizable," he said.

"Plus, Brazil isn't exactly a screaming buy at these spreads. Brazil does offer some value relative to a fairly rich EM universe, true, but not really in absolute terms."

Heavy Asia supply

Heavy supply is also expected in Asia. But over-saturation is not a concern, given that locals will step up and buy that new paper, according to the buy-side source.

"And if anything, we've always argued that in Asia there is lack of supply.

Industrial and Commercial Bank of China (Asia), China Development Bank, Republic of China and South Korea are just few of the Asian names expected to come to market in September.

"It will all depend on the quality of the credits that come to market, but usually I wouldn't say that is something to worry about Asia," said the source.

And the lack of supply is the reason why Asian paper in general has been trading firmly, according to the source.

"Everybody is fighting to get the bonds and there's just not enough bonds. Additional supply in Asia is not necessarily a bad thing.

"Of course, it depends on which credit, but Asia is well known for lack of supply."

One Asian corporate credit that has been grinding tighter is Hong Kong's Hutchison Whampoa, which was narrower by around two basis points at the end of Thursday's trading session in Asia.

"There is a lot of supply on Hutch - that's not going to be the problem for Hutchison. You have good earnings coming out and positive news for the credit and that is what has been driving the spreads," said the source.

"And the better tone in emerging markets in general, positive news for the credit - people are willing to buy it."

Despite losses from its 3G phone service, Hutchison Whampoa posted a net profit of $1.6 billion.

Payroll numbers coming up

Next week, emerging market investors - like others - will be keeping tabs on the Sept. 3 release of U.S. non-farm payroll numbers.

"That's obviously going to have an impact on Treasuries and from there on the riskier assets in general," the source said.

"But maybe it might be offset by the fact that it is still quiet and it's pre-Labor Day.

"That is something that everybody is curious to see what is going to happen after last month's low number.

Non-farm payrolls rose a paltry 32,000 in July, resulting in an emerging market surge.

Depending on the weakness or strength of those numbers, "the Street will make sure to move the market" even with so many investors away, said the source.

After the Labor Day holiday, investors can expect to see some more trading volume, "and maybe some more profit taking if spreads get tighter," added the source.

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