Emerging market debt trades flat after Monday's sell-off; Ecuador rebounds

By Reshmi Basu and Paul A. Harris

New York, July 26 - Emerging market debt calmed down a day after the sell-off on Monday sparked by the ongoing political scandal in Brazil.

At the open Tuesday, Brazilian paper was again hit, this time by concerns over the continuing investigations of the postal authority and the voting irregularity issue, said a market source.

Leaders of president Luiz Inácio Lula da Silva's Workers Party (PT) have admitted to improper campaign financing. The fear among investors is that Lula will be implicated.

The market source said that recent issues from Brazilian corporates such as Companhia Siderurgica Nacional SA's and Unibanco's perpetuals were off about one dollar point from the issue prices at the open, which he attributed to profit taking and weaker U.S Treasuries.

But by the end of the session, Brazil came back, according to a buyside source.

"Stock market is up. Currency is strengthening. The EMBI had opened up weak, but the EMBI is tighter on the day, slightly," he added.

"Looks like Brazil is basically unchanged today [Tuesday] as far as spreads."

Furthermore, high beta names that were hit hard on Monday from a Brazilian contagion effect rebounded.

"Ecuador seems to have come back," the buyside source noted.

"It got hit unduly yesterday [Monday]."

One reason why the market appeared less jittery was that there was "no smoking gun" in Tuesday's congressional hearing regarding corruption allegations in Brazil, remarked the buyside source.

"It's buy the rumor, sell the fact trading action. Since Lula was not implicated, you have a bit of relief going on.

"Clearly the bond market is not rallying, but it didn't go down either."

However, prices in Brazil nudged lower. The Brazil bond due 2040 lost 0.20 to 115½ bid. Meanwhile, the Ecuador bond due 2012 added one point to 98¼ bid while its bond due 2030 increased 1.05 points to 85.80 bid. The 2012 had lost half a point in trading Monday while the 2030 had dropped three points.

The buyside source remarked the persistent political ruckus in Brazil will continue. Every time the end is in sight, the story just stays there. Nonetheless, the source said the scandal has not prompted him to change his exposure to the country. But the political landscape has always made him slightly nervous.

"We've been slightly underweight for awhile. But that has to do more with valuations than political concerns.

"This is the type of stuff that I worry about. In the big picture, while the market has corrected here, it really hasn't done that much to the underlying market," he commented.

Pipeline dozes off

Essentially summer sloth has shut off the primary market, said sources. Regulation S deals are making up the bulk of the pipeline.

In primary action, the Russian Bank for Development revised price talk on its $150 million offering of three-year loan participation notes (Ba1/BB+) to the 6½% area from 6 5/8% to 6¾% on Tuesday.

The Regulation S-only transaction, via Barclays Capital, could price as early as Wednesday.

However bucking the Reg. S trend, Thailand oil and gas conglomerate PTT PCL talked its $250 million offering of 30-year notes (A2/BBB+) at U.S. Treasuries plus 155 to 165 basis points.

Pricing is expected to take place on Wednesday.

JP Morgan has the books for the Rule 144A/Regulation S offering. Bear Stearns & Co. is the joint lead manager.

Meanwhile, two corporates did price Tuesday. Malaysia's Hong Leong Bank Bhd. priced $200 million of 10-year bonds (Baa2/BBB) at 99.848 to yield mid-swaps plus 78 basis points.

Barclays Capital and BNP Paribas were the bookrunners.

And ammonia producer Stirol priced $125 million of three-year notes (B3//B) at par to yield 7.873%.

The loan participation notes are structured as a bullet and carry a long first coupon.

ING was the bookrunner for the Regulation S transaction.

"People have done a pretty good job on the sovereign side of financing," said the buyside source, who said he expects the quiet primary tone to continue.

"Mexico is done through next year. There are not a lot of people who need to come to the market.

"Most of these countries have very good reserve positions, which also reduces their need to raise cash in the primary market," he noted.

Missing Brazilian corporates in primary

However, the buyside source is surprised at the lack of Brazilian corporates in the primary market. He expected that more would tap the capital markets, following the country's successful C bond swap in order to take advantage of the country's positive market tone.

The Treasury exchanged $4.2 billion of its C bonds for $4.4 billion in new 8% amortizing global bonds due 2018 on Friday.

Bearish on EM

On Tuesday, Prospect News spoke to Jephraim P. Gundzik, president of Condor Advisers, Inc, for his assessment as to where the market is going. The firm provides comprehensive emerging markets investment risk analysis to individuals and institutions worldwide.

Looking ahead, Gundzik said he is bearish as investors are ignoring the real risks in the asset class. In the first half of the year, emerging markets performed well, mostly led by compression on U.S. Treasury bond yields. Low yields led investor to sweep certain stories under the carpet, he said.

"There's a huge gap between perception of risk and actual risk in our markets. People get hooked on a good time, more or less.

Gundzik said he is convinced that the market will turn more bearish in the second half.

"And I think you saw the spark of that last week when China started to change its currency format, the revaluation of the yuan.

"Although not a huge step so far, I think the move to a basket type of trading for that currency has a pretty significant inflationary impact on the U.S.," he replied.

Factors that gave support to low yields in the United States will become unsupportive, he added.

"There's not going to be huge incentives from car manufacturers to discount their products. How much more discounting can they do realistically? That is one thing that has kept inflation under control."

Gundzik added that Chinese imports in the United States have also helped stem inflationary pressures. Both of those supporting mechanisms will fade in the second half, as "quotas on Chinese products are put back into force" and the revaluation of the yuan will push up the prices of goods, he remarked.

"And the price of oil is going to continue to rise. There are two huge problems in the oil industry right now in investment terms. First that oil is denominated in dollars."

The weak dollar makes it difficult for foreign companies in non-dollar countries to invest in new production and exploration.

"And second, instability is spreading in a lot of oil producing countries. And that also is holding back investment. The oil picture is going to remain the same through at least 2006, pretty much as long as we stay in Iraq," he added.

Bearing on Brazil, bullish on Argentina

Gundzik warned against investing in Brazil and the Philippines.

To him, the Philippines is extremely overvalued in the bond market, adding that the country is a "debt trap." The political maelstrom surrounding embattled president Gloria Arroyo does not help as her government fights for its survival.

"It seems that investors are completely unaware of the fiscal situation. There is no way to avoid the continued expansion of their public sector debt. The economy can't grow as quickly as its public sector debt is going to grow," he noted.

"That's probably the best default candidate in the world right now."

"But people still want to buy it at 400 [basis points] over Treasuries for whatever reason."

And Brazil is heading for a disaster in the next year or so, he warned.

"Again, it's a situation of governance. It's always been a problem in Brazil. They are going to face much more volatility as the election approaches."

Nonetheless, Gundzik is bullish on Argentina, calling it one of the better values in emerging markets.

"They are completely walking away from the economic policies that had been administered by the IMF in the country for the last 15 years.

The country has implemented a strategy that runs counter to the International Monetary Fund's policies, which emphasize high investment returns for foreign investors.

"And now, it's the other way around. They want to create higher social return in Argentina to reduce poverty and unemployment in the country - that were all created by the IMF," he said.

"Their abandoning of the so-called Washington consensus is driving their economy right now.

"It's not only boosting consumer confidence and personal consumption, it's also boosting foreign investment from Asia and other Latin American countries."

Gundzik does not see any problem areas for Argentina. A remote negative could stem from mid-term elections, but he is confident that the government will enjoy a strong showing come election time.

The buyside source quoted above added that Argentina's performance depends on what measuring tools participants use. For instance, its JP Morgan EMBI index component is underperforming the market in terms of returns on the year. But its Boden bonds are outperforming the market.

"I think Argentina is getting more traction lately because you do have a lot of corporate restructurings.

"They have gone back into the index, so if you are an index-centric investor, that's going to create demand," he remarked.

"It has a ratings again. And it's single-B. That creates another group of investors, who can look at it.

"I guess you can call it a sort of virtuous circle."

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