Emerging markets debt up on U.S. core markets strength; Brazil sets exchange spread for 2037 bond

By Reshmi Basu and Paul A. Harris

New York, Aug. 2 - Emerging market debt regained momentum Wednesday, following rallies in U.S. core financial markets. The uptick came after Tuesday's session, which saw spreads widen by two basis points on profit-taking ahead of Friday's U.S. non-farm payroll numbers.

In the primary market, Brazil said it would issue up to an additional $1.5 billion in 7 1/8% bonds due 2037 at a spread of 205 basis points over Treasuries as part of its proposal to buy back existing bonds with maturities ranging from 2020 to 2030.

The exchange started last Thursday and ended at 3 p.m. ET on Wednesday. The results will be announced on Thursday.

"The Brazilian buyback has had a positive impact," noted Enrique Alvarez, Latin America debt strategist of think tank IDEAglobal.

Moreover the issue spread of 205 basis points was slightly wider than where the 2037 bond was bid in the morning. The bond was spotted at a bid spread of 200 to 203 basis points over Treasuries.

"Overall, I think there was a little bit of an incentive given there to get those bonds done," he said.

During the session, the Brazilian bond due 2037 gained 0.95 to 99.90 bid, 100.25 offered. The bellwether bond due 2040 added 0.30 to 128.55 bid, 128.60 offered.

In other news, new deals in the market have seen support.

On Tuesday, Korea's GS Caltex Corp. sold $200 million of 10-year bonds (Baa1/BBB+) at 98.98 to yield a spread of Treasuries plus 114 basis points or 6.138% via Deutsche Bank and Goldman Sachs.

The deal came quickly - announced and launched in a day, according to a trader who focuses on Asian fixed income.

"They come regularly, so people know them. But even so it was a pretty quick deal," he added.

And there appears to be some demand for these smaller issues.

Another issue that has done well in secondary trading is the retap by the Philippines. On July 25, the country sold $750 million in a two-part reopening of its sovereign bonds (B1/BB-/BB).

The issuer reopened its bonds due 2016 to add $300 million. The issue priced at 103.125 to yield 7.531% or 246.4 basis points over Treasuries.

Meanwhile it retapped its bonds due 2031 to add $450 million. Those bonds priced at 99.25 to yield 7.819% or 262

The Philippines issue was pretty constructive, noted the trader, who added that the sovereign's curve had flattened quite significantly.

"Now you are seeing some underperformance at the long end of the curve versus the middle of the curve," he added.

"But there were some extremely overbought long-end positions," he explained.

"This seems to be moving us back to something more normal."

Both have since traded well. The 2031s are at 100.375 bid, 100.625 offered, up about 1½ points from where they were at the time of the add on. The 2016s are 106.625 bid, 107.125 offered, up around 2½ points from where they tapped.

Citigroup, Deutsche Bank and JP Morgan were the bookrunners.

Finally there are rumors that Indonesian department store company Mata Hari will tap the capital markets. There are also whisperings that Noble Finance (Indonesia) will bring a deal.

EM inches higher on stocks, Treasuries

Emerging market debt tracked U.S. stocks higher Wednesday as equity markets posted gains on positive earnings from U.S. corporations. The Dow Jones Industrial Average shot up 74.20 points to close at 11,199.93.

Additionally, U.S. Treasuries added support as the 10-year Treasury note extended gains to remain below the 5% barrier. At the close the note stood at 4.97% compared with 4.98% from the previous session.

That combination of gains in stocks and government bonds is persuading investors that the market will see lower Treasury yields over time, resulting in an overall firmer market tone, according to market sources.

"The fact that Treasuries have performed so well, and the equity markets as well, has given us a decent amount of support," according to a trader.

"That has served to stabilize the risk markets, generally."

Meanwhile, investors are adding to their positions, observed IDEAglobal's Alvarez. Many market participants are convinced that the Federal Reserve will pause at its Aug. 8 meeting, thus bringing an end to the current monetary tightening campaign, which has seen 17 consecutive rate hikes

"The market itself is still not sensing a whole lot of risk at this point in time - be it geopolitical or from the U.S. interest rate side," commented Alvarez.

"I think that's why a lot of people are piling it on to ride this wave."

However, volatility may come back depending on how benign Friday's release of non-farm payroll numbers is. But for now, the market is moving higher on expectations of a tamer to lower interest rate landscape ahead.

"The Treasury market is definitely positioning itself for a pause in the current round of interest rate hikes by the Fed," observed the trader.

"There is definitely some money being added to the risk markets."

Nonetheless, liquidity has been low in emerging markets, which is typical for the month of August.

"There has not been an enormous amount of client flow," observed the trader.

Still, there has been evidence of real money coming back into the market. Hedge funds appear to be undecided, noted Alvarez, adding that they may still be banged up from the recent sell-off in May and June.

Oil spike helps Latam

Furthermore, Alvarez observed that the market is revisiting a similar phase that was seen last year when a strong run-up in crude oil prices boosted Latin American credits.

On Wednesday, crude oil prices jumped to their highest level in two weeks on worries that tropical storm Chris may be upgraded to hurricane status as it heads for the Gulf of Mexico next week. There are fears that the storm will impair U.S. oil production.

As a result, crude oil prices jumped $0.90 to end at $75.81 per barrel.

Normally that oil spike would be a negative for equities because it could be passed through as higher inflation. But just like a repeat of last summer, the opposite is happening. Counter to logic, the market is rallying on the expectation that higher oil will translate into flatter or lower interest rates, remarked Alvarez.

During the session, Latin American oil credits traded up, The Ecuadorian bond due 2030 gained 0.25 to 101.35 bid, 101.50 offered. And the Venezuelan bond added 0.40 to 123.60 bid, 124 offered.

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