Deal drought in the primary; speculation over coming week's deals; EM spreads tighten in trading

By Paul Deckelman and Aaron Hochman-Zimmerman

New York, July 6 - Emerging markets debt outperformed a slumping Treasury market in trading Friday as the economic data that hurt U.S. government securities was seen as having both positive and negative aspects for emerging economies.

In the primary market, the holiday week ended with a stagnant day.

Many Russian and CIS banks and others with deals poised to come to market have been waiting out the rough seas to price. Some of those who have not yet pulled their deals have been waiting for weeks.

"The overall environment is not bond friendly," said a market source.

Meanwhile $81 million came into emerging markets funds during the week just completed.

Wednesday marked the 11th consecutive week of new money flowing into the sector. Year to date, $4.62 billion has entered emerging markets, according to EPFR Global.

Treasuries off, EM spreads tighter

In the emerging market secondary, the more robust than expected U.S. job creation numbers released Friday proved to be something of a double-edged sword, with some market observers seeing it as a negative, since it makes the chance of a Federal Reserve cut in U.S. interest rates even more unlikely than it was previously, while others saw the glass as half full - signs of stronger activity in the United States are a good thing for countries which depend heavily upon exports to the world's largest economy.

Treasuries fell in response to the news that employers added 132,000 non-farm jobs to the economy in June, somewhat above the roughly 125,000 which Wall Street was looking for, while the May jobs-creation numbers was revised sharply upward, to 190,000, from 157,000 previously. Hourly wages were up 0.3%, and the unemployment rate stayed at 4.5% - a nearly six-year low - both as expected.

The stronger-than-expected economic picture caused Treasuries to retreat and their yields to widen, with the benchmark 10-year paper's yield moving out 4 bps on the day to 5.18%, and at one point intraday it spiked above 5.20%. The 16 bps widening for the week was the sharpest one-week increase in more than a year.

With Treasuries continuing to widen, even emerging issues that were on the downside were able to tighten, spread-wise; the widely followed EMBI+ index compiled by JP Morgan & Co. tightened about 8 basis points on the day to around the 160 bps level. That is a pickup of 15 bps from the EMBI+'s recent wide spread, but is still about a dozen bps wider than the all-time tight levels in the upper 140s seen at the beginning of June.

A decent week for the market

"If you put it on balance, the market has acted positively [this week], given today's run-up in U.S. 10-year yields," said Enrique Alvarez, head Latin American debt strategist for IDEAglobal, an international research company.

He noted that there was spread compression versus Treasuries on the week, and "a slight positive return. So on balance, it is a favorable outcome for the market."

However, he added the caveat that "you need to contrast that with the fact that we normally are at a shortfall as far as liquidity in overall trading volume in these days - so I'm not sure you can take the overall tone of the market at face value."

He said that the coming week could see "some modifications" in prices and spreads with more participants back in the market, which had been somewhat stymied in the past week by the quiet U.S. financial markets over the July 4th holiday period.

The past week, however, was by no means a total waste. "If you look at the fact that we're trading at 5.18% levels on the U.S. 10-year, and we did bump up against 5.21% earlier in the day, that did not spook LatAm - it did not unearth some of the prior external stories that could be potentially negative for emerging markets."

Analyst likes Venezuela's outlook

Alvarez said that the volatile, high-beta credits like Ecuador and Venezuela "have actually put in pretty decent performances" over the past few days in coming back from the horrendous plunges seen the week before.

In the case of Venezuela, "the market is finally having its arm twisted as far as the influence of very high crude oil prices into this credit." Venezuela, one of the largest oil producers in the world, is awash in oil money - particularly with crude trading Friday at over $72 per barrel, a 10-month high.

He noted that the spread on the country's bonds, on average, is "still above 300 basis points [over Treasuries] when you look out the curve at about the 2027 maturity," the benchmark issue - but added that "there have been some price advances this week, which is a good contrast to what's happened in recent memory."

In Friday's dealings, Venezuela's 5¾% notes due 2016 were seen having improved to about the 86 1/3 level, its yield having tightened 3 bps to 7.96%.

He also saw "something similar for Argentina, where prices have been slightly firmer, but it really hasn't had as much compression as Venezuela."

Argentina's bonds notched solid early gains, but ended up giving back about half of them by closing time, although the bonds still finished up on the day. The country's dollar-denominated 8.28% benchmark issue due 2033 was quoted up ¾ point to end at 96.75, while its yield tightened by 7 bps to the 8.55% region.

Ecuador posts gains

In Ecuador, Alvarez said, "the result has been very mixed, because the domestic political agenda continues to be an interference to the overall price action of the sovereign debt."

However investors shrugged off their fears on Friday, with Quito's 10% benchmark notes due 2030 quoted up 1 1/3 points to just under 82.5, while its yield narrowed 20 bps to the 12.30% level.

The bonds were firming after having been roiled earlier in the week by the latest pronouncements by the country's populist president, Rafael Correa.

Alvarez said Correa's latest warning that Ecuador could decide to default on its more than $10 billion of external debt, delivered during a news interview this week, is really nothing new. "He's basically reiterating a threat that he's made continuously, and which basically plays to his political base, which is at the low end of the social-economic spectrum."

However, of perhaps greater concern is the president's promotion of a political measure that would essentially nullify the independence of the country's central bank, bringing it under the control of his regime. Correa said he wants the upcoming special national assembly that will re-write the country's constitution to approve the measure.

"I think that's going to be a major stumbling block, because it leads to a number of questions about what's ahead for Ecuador, and what happens if this particular desire of his to have control of the central bank, is not granted by the assembly," Alvarez said.

Brazil, Mexico bonds easier

Apart from those names - which have been the biggest losers on the year so far, but which have recently bounced back solidly from big losses - some of the normally better-performing names were seen unchanged to slightly lower, with Brazil's widely traded global benchmark 11% bonds due 2040 seen off nearly ½ point to 130.75, while Mexico's 2017 global benchmark bonds were off about 3/16 point to around the 97.5 level. Its 2016 peso-denominated bonds were quoted off 0.10 on the day to about the 96.85 level, with the yield wider by 1 bp to 7.70%.

Alvarez believes that the environment, "if it continues to be a very complex, volatile environment, in general is going to be of little corrosion [to the returns of] Panama and Peru, and I think those would be positive to hold in this environment."

He said that the area of risk "is the credits that have accumulated somewhat strong year-to-date total returns," such as Colombia, Brazil, the Dominican Republic and Uruguay, due to the fact that "as Treasuries rise, the risk factor from the U.S. side continues to elevate. If we have more noise from the U.S. credit derivatives market, or if we have more noise related to financing for LBO or private-equity type activity, we may have a continued cooling of overall interest in investments in high-risk type instruments. That's why I would tend to view Brazil, Colombia, D.R. and Uruguay with more caution than some other credits."

Philippines eyes debt-for-debt swap

Outside of Latin America, Philippine sovereign bonds were seen to have firmed, after a government official said Manila is considering issuing new 10-year peso- and dollar-denominated bonds, which would be exchanged for its existing debt. Finance undersecretary Roberto Tan said that such a swap would increase the liquidity of the nation's debt markets and cut borrowing costs.

The Philippine 2032 bonds were quoted at 96.375 bid, 96.75 offered.

The five-year credit default swaps contract on Philippine government debt was seen steady at a bid spread of 110 bps.

Junk troubles hurt EM, analyst says

A Latin American market analyst noted the effects that the recent problems in the high-yield market have had on emerging markets.

"A lot of deals in the United States have suffered significant pullbacks due to the publicity affecting the leveraged buyouts and private equity financing side ... and this tends to filter into issuance for higher risk categories such as EM with ease," the analyst said, adding that the lack of strong covenants in recent high-yield deals has caused concern for investors.

"Also, today's U.S. Treasury yield spike to 5.18% levels on the 10-year should also pressure the issuance pipeline," the analyst said.

"Spreads may tend to widen on a rehash of noise related to the U.S. sub-prime," the analyst added.

A source in the Asian markets expects the low-volume holiday spirit to continue in the coming week.

"[The market] had a weak close in Asia, and stronger than expected non-farm numbers are not conducive to a good start to next week," the source said.

"[There are] plenty of issuers waiting in the wings," the source added.

An emerging markets researcher speculated that the market might briefly pick up volume within the next few weeks.

"I don't have the impression that the EM pipeline is massively large," the researcher said, but conceded that better conditions may arrive shortly.

"You may over the next couple of weeks see deals trying to get done before the August doldrums," the researcher added.

Russia's Rosneft expects to end its roadshow during the July 9 week for its benchmark-sized deal. Romania's Telemobil is also marketing its $125 million seven-year deal.

The low volume may have been a blessing for some, according to another source.

"Little volume overall may be explaining why prices held on relatively well amid a significant sell-off in U.S. Treasuries," the source said.

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