Emerging market debt posts second straight losing session, high-beta group hit more

By Reshmi Basu and Paul A. Harris

New York, Aug. 24 - Emerging market debt posted another sell-off Thursday on more follow through from Wednesday's session. Surprisingly soft U.S housing numbers once again spooked the asset class.

On Thursday, the Commerce Department reported an unexpectedly large drop in sales of new homes. That came a day after the National Realtors Association said there was a sharp decline in existing home sales for July, triggering losses across equities and emerging markets.

Those two reports in tandem made for a volatile session Thursday as high beta names, particularly Brazil and Ecuador, saw more volatility on fears that the United States economy is heading into a greater-than-expected slowdown.

Over the last few days, market attention has now turned to the U.S. growth story, according to Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal.

"Overall, people are a little bit worried about risk and about what is going to happen in Iran," he said.

In general, the asset class has widened out somewhat in the past few days, noted a sellside source.

While prices have not seen a sharp decline, emerging markets have not been able to keep up with the U.S. Treasury rally, noted the source. Thursday saw the yield on the 10-year note break below 4.80% before closing out the session at 4.81%.

"The 10-year Brazil paper is 15 to 17 basis points wider than it was at the tights seen in the past week and a half.

"Some of that can be chalked up to the market being so illiquid right now," remarked the source.

In mid-afternoon, the spread on the JP Morgan EMBI Global index was spotted at 196 basis points versus Treasuries, from 193 close on Wednesday.

"The market is squishy, with very little volume," observed the sellside source.

Brazil, Ecuador down

In trading, high beta Brazil and Ecuador were underperformers, unhinged by news on both the local front as well as the U.S. growth story.

Brazil was hurt by news that its primary budget surplus decreased in July to a lower than expected R$5.62 billion from R$10.44 billion in June.

During the session, the bellwether Brazilian bond due 2040 shed 0.15 to 129.35 bid, 129.50 offered.

Ecuador also saw more weakness, following Wednesday's remarks from the leading presidential candidate former vice-president León Roldós regarding debt restructuring and his opposition to paying down the country's debt during his possible administration.

Former-finance minister Rafael Correa, who has close ties with Venezuelan president Hugo Chavez, has moved up in support heading into the October election, according to a poll published on Wednesday. Increasing support for the left-winger is somewhat of a worrisome development for investors, according to Alvarez.

Furthermore, similar comments regarding an unwillingness to pay debt are expected to become more commonplace leading to the election, according to a market source.

But unless Correa wins, any sell-off on the back of such comments from any other candidate should be seen as a buying opportunity, according to the market source.

On Thursday, the Ecuadorian bond due 2015 lost 1.25 to 103.75 bid, 104.25 offered while the bond due 2030 gave up 1.75 to 100.60 bid, 101 offered.

EM near tights

On Wednesday, the EMBI Global index closed at 193 basis points versus Treasuries. Since the beginning of August, the spread on the EMBI Global index hit a high of 199 and a low of 182, which means that asset class is 11 basis points wider from the tights of the month, according to the sellside source.

Of the total, two or three basis points of widening can be explained by the fact that the benchmark has been moved to the new long Treasury bond due 2036 from the Treasury bond due 2031, observed the source.

"Emerging markets has a slightly higher weighting of longer-dated debt than is true of some other indices. Certainly emerging markets has more longer dated debt than high yield, which doesn't have long-dated debt," the source noted.

Pipeline to build

On the primary front, the Korean pipeline is expected to build-up, according to the sellside source.

Among sovereigns, Turkey is expected to tap in September.

"That's the only issuer that could do something substantial - a billion to a billion and a half," noted the source, adding that Lithuania is anticipated to do a small tap of a euro-denominated issue.

Meanwhile earlier this week, Brazil said it does not plan to issue again in a foreign currency until the end of 2008.

"Given that sovereign issuance is so small there is going to be more focus on the corporates or local markets. And people are putting more and more money into local markets," remarked the sellside source.

And lastly some of the coming Asian deals are probably going to start roadshowing in Europe next week.

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