Emerging market paper firms as CPI numbers draw buyers, Venezuela and Ecuador up with oil

By Reshmi Basu and Paul A. Harris

New York, May 14 - Emerging market debt traded higher Friday as the U.S. consumer price index data invited investors back into the market.

"The market was oversold and the fundamentals are strong," said a fund manager. "The CPI numbers were a catalyst. People wanted to come back to the market."

The JP Morgan EMBI Index rose 1.4% during Friday's session while its spread narrowed 6 basis points to 507 basis points.

While inflation is sneaking back into the United States, it is not with the roar once feared. Investors' stress levels relaxed a bit as the CPI numbers came in line with expectations, signaling that the Federal Reserve hike may not be as potent as feared.

The numbers gave the added incentive needed by bearish investors who had been shorting the market.

"The negative sentiment that we experienced in the last couple of days is over," said a strategist. "Investors felt like the market oversold and this was a good entry point."

The Labor Department reported that U.S. consumer prices rose a seasonally adjusted 0.2% in April, the smallest increase this year.

But Friday's cautious optimism is teetering on shaky legs, according to a trader.

"I think the worst is behind us but you never know," said a trader. "Another set of numbers can turn it upside down. The market is having knee-jerk reactions to any news out there."

In early morning trading, Brazil felt the after-glow from Friday's numbers.

"Right after the numbers this morning, we saw mild interest in Brazilian paper on the short part of the curve," said the strategist.

Brazil's 11% bond due 2040 was around 2½ to 3 points higher at 87.25 bid, 87.875 offered, up from Thursday's 84.875 bid, 85.75 offered. The benchmark C bond 8% due 2014 was slightly better at mid-morning, quoted at 87.875 bid, 89 offered compared to Thursday's 87.25 bid, 87.75 offered.

"Then during the day as the market came down a little bit more, we saw interest on the whole part of the curve," the strategist added.

By late afternoon he put the Brazilian '40s up about 3 points and the C bond up about 1½ points.

Argentina's 11 3/8% bond due 2017 was 32 bid, 32.625 offered at early morning from Thursday's 32.125 bid, 32.75 offered.

And in Asia, the Philippines' 6½% bond due 2017 was at 96.875 bid, 98.125 offered, from Thursday's 97 bid, 98.125 offered.

Oil prices aid Ecuador, Venezuela

Meanwhile, there was continuing interest in paper from oil producing countries such as Ecuador and Venezuela as the price of oil shot up to $41 per barrel. Despite political volatility in both nations, record-high oil prices have been reeling in investors.

Opposition forces have been working to oust leftist President Hugo Chavez through a referendum, erupting in street violence.

"While the whole market sold off, in terms of relative value they did a little better," said the strategist, describing the performance of the countries' bonds earlier in the week.

On Friday Venezuela's 9¼% bond due 2027 gained more than two points by mid-morning to 81.75 bid, 82.125 offered from Thursday's 79.125 bid 79.50 offered.

"And in Venezuela, the short part of the curve holds pretty well," said the strategist.

Hedge funds must de-lever, predicts investor

In the face of looming interest rate hikes, hedge funds are being forced to reverse the leverage they had previously applied to take advantage of low borrowing costs - and that de-levering will have to continue, predicted Diane Keefe, portfolio manager of Pax World High Yield Fund, whose fund submits the companies that it invests in to a series of social issues screens.

"One economist I saw interviewed yesterday said that a lot of what we are seeing is the unwinding of hedge fund positions that were based on borrowing at a really low cost of capital, and just playing the game of being a leveraged investor," said Keefe.

"And as the Fed Funds rate increases, everything that is based off of that rate is going to increase. So the hedge funds are going to have to de-lever."

While most emerging markets debt has stabilized over the past couple of days, the U.S. high yield has still been hit with volatility, said Keefe, whose high yield portfolio has 6% exposure to emerging markets corporates.

"I think high yield has been trying to rally in the mornings. And then emerging markets debt or something else causes it to trade off in the afternoons," Keefe said.

Keefe added that she believes there are opportunities to buy because the markets have been too aggressive about pricing in the increased to U.S. interest rates.

"So this economist was saying that not only have we priced in quite a few rate hikes this year. We've also priced in the idea that there are going to be quite a few rate hikes all through 2005 and 2006," said Keefe.

"I heard today that somebody thinks the Fed Funds rate will be at 2.5% at the end of this year and 3.5% by the end of 2005. But that's already priced in.

"I'm not convinced that it's going to be a straight shot to 5% before we have any kind of rally here."

Corporates such as Brasil Telecom, Telemar and Embratel have been hit in the emerging markets, "but the credits are fine," according to Keefe, who will continue to hold on to them.

"And if I had not bought them before I would be buying them more now," said Keefe.

"I don't want to get too overweight in emerging markets because it does have this volatility associated with it.

"Right now I'm in the top 7% of junk funds, even with this [6%] emerging markets exposure. I don't want to do anything to disturb that by getting into areas that are affected by things like hedge fund selling, more than high yield is already affected by that," added Keefe.

And finally, the return of the Congress Party to India will have little effect on the nation's paper essentially because it does not have any.

Some had expressed concern that the new party would align itself with the Communist party, reversing the nation's privatization reforms.

"This is more of an issue for the equity markets," said the fund manager. "India doesn't have a sovereign. And the only corporate that has debt is Reliance Industries."

Reliance Industries has been in the pipeline with another deal, a $750 million bond due 2009 via Credit Suisse First Boston and ABN Amro. Pricing is expected in the third quarter.

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