Emerging market debt flat; outflows continue to bleed

By Reshmi Basu and Paul A. Harris

New York, May 21 - Emerging market debt traded flat during Friday's session in response to increased geopolitical concerns and uneasiness about the outlook for action by the Federal Reserve.

However Friday was steadier after Thursday's sell off in Brazilian paper sparked a broader downturn in emerging markets. Investors were displeased with the Brazilian Central Bank's decision to hold the benchmark interest rate steady.

"Things appear to be a little better today," said a buy-side source. "It seems like Brazil and Turkey are driving it."

Meanwhile, investors' reluctance to buy Turkish paper was increased by a series of attacks. An explosion in Turkey damaged four British bank branches just before the arrival of Prime Minister Tony Blair.

"Turkey is down almost 10% for the months," the source said. "It looks like it'll reverse today, but still it will be the worse performer of the month."

The JP Morgan EMBI Index was flat. Its spread to Treasuries widened by four basis points to 513 basis points during Friday's session.

Among the movers, Russia's 5% bond due 2030 firmed slightly Friday to 90.625 bid, 91.25 offered, from Thursday's 90.125 bid.

The buy-side source said Brazil, Turkey and those driven by liquidity like Ecuador and Peru had been the most impacted on Friday.

Record-high crude oil prices have pushed up prices on the paper of oil-producing countries - but several of those countries are seeing growing political noise.

"Ecuador and Venezuela have serious political drama," said the trader. "Geopolitical risk is at an all-time high."

Of late, President Hugo Chavez has been voicing outcry over an imperialist plot to assassinate him.

On Thursday election observers said they would be allowed to monitor verification of disputed signatures on a petition seeking a referendum against Chavez. The president had threatened to expel international observers.

Referendum supporters will get a chance May 27 to 31 to reconfirm the validity of more than 1 million disputed signatures. A vote against Chavez could be held on Aug. 8 if around 525,000 more signatures are declared valid during the checks.

Meanwhile in Ecuador, president Lucio Gutierrez's popularity continues to slip. Rumors that his finance minister Mauricio Pozo, a Wall Street darling, may resign would - if they come true - be a blow to the nation's standing in the capital markets.

One buy-side source said any boost from oil prices has been overshadowed by other issues such as political worries and interest rate fears.

"We've had the rally from $30 to $40 in oil," said the buy-side source.

"I really haven't seen the oil countries benefit. I think they've been swamped by other factors such as geopolitical concerns and the Fed hike.

"My guess is that if oil was to fall countries like Russia and Ecuador would probably do better," said the buy-side source.

"What I think is driving the market has been more the risk-aversion trade than any view on oil."

Some believe that emerging markets has bottomed out for the short-term after its recent plunge. But they still expect investors to remain defensive in the face of a host of issues such as geopolitical concerns, Fed action and China cooling its economy.

"The mindset is not as bad as a few weeks ago, but everyone is on top of the headlines," the source said.

Korea Land sets guidance

In the primary market, Korea Land Corp. set price guidance for its planned offering of $500 million 10-year senior unsecured notes (A3/A-) in the area of 125 basis points over U.S. Treasuries.

Pricing could take place after the completion of its roadshow in New York on Monday. However, the deal is subject to market conditions.

And the buy-side source described the talked spread as too tight for his liking.

"I can buy mortgages at 125 over, guaranteed by the U.S. government," said the buy-side source.

"I have the Ginnie Mae rule. If your bond doesn't trade wider than the Ginnie Mae triple A guaranteed by the U.S. government, I'm not going to play," he added.

Citigroup and Deutsche Bank are running the books on the Rule 144A/Regulation S offering for the Korean land utilization company.

CSN joins calendar

Brazilian steel producer Companhia Siderurgica Nacional SA plans to issue $150 million of eight-year notes (-/-/BBB-).

The notes will be backed by receivables from the export of steel products.

"It's going to be an asset-backed deal, it's going to be offshore and it's going to be much tighter than where CSN trades." said a source.

Citigroup and BNP Paribas are the joint bookrunners on the Rule 144A (with no regulation rights)/Regulation S offering.

Painful week of outflows

Emerging markets debt underwent another "painful week" of negative flows from dedicated funds.

A market source told Prospect News that EmergingPortfolio.com Research Fund reported that for the week ending May 19 the dedicated emerging markets debt funds saw net outflows totaling a whopping $308 million (1.9% of assets), even worse than the previous week's already hefty $228 million outflow.

The outflow came despite a plus 2.3% return for JP Morgan EMBIG over the same period (May 13-19), reflecting the fact that fund flow data tends to provide a lagging indicator of market performance.

In a reversal of the trend seen in February through March, emerging market debt funds have now seen outflows for five of the last six weeks, with the less volatile four-week moving average showing outflows at the worst level since September 2001.

Also, according to the source, EmergingPortfolio.com, which tracks 251 dedicated emerging market bond funds, reported that international debt funds, which can invest in both emerging and developed country bonds, also reported outflows totaling $399 million (0.5% of assets). However, that was something of an improvement over the previous week's $553 million outflow. International debt flows have now been negative for five straight weeks.

The bleeding also continued in U.S. high-yield mutual funds, which saw redemptions totaling $989 million (1.2% of assets), according to AMG Data Services. By comparison, the previous week's outflows totaled $2.1 billion. Junk funds have now seen net redemptions for nine of the past 10 weeks.

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