Emerging markets stage impressive rally ahead of long weekend; Aries trades above par

By Reshmi Basu and Paul A. Harris

New York, July 2 - Emerging markets paper soared in trading Friday as Treasuries rallied on sluggish U.S. job data - but the massively oversubscribed Aires deal remained the headline story.

Treasuries perked up on news that 112,000 jobs were created last month, falling way below the 250,000 new jobs forecasters had expected, providing evidence that the U.S. economy's expansion is slower than thought.

The Brazil bond due 2040 jumped 2.95 to 96.7 bid while the C bond was up 1.875 to 93¾ bid.

But the giant €3 billion and $2.4355 billion bond deal brought to market Thursday by Aries Vermogensverwaltungs GmbH continued to dominate attention.

The question weighing on investors' mind is just how to chalk up Germany's repackaging of bilateral debt owed by Russia. The deal resold Paris Club debt as credit-linked notes through a special purpose vehicle.

The book size for the offering was over $20 billion - to the reported displeasure of the Russian government.

Russia immediately saw its paper flogged when Germany made the announcement of securitizing Soviet-era debt. But while Russia's paper has since recovered, the market may be over-flooded with Russian paper.

"It was a huge book for emerging markets, if you consider that transaction to be 'emerging markets'," said a market source.

"We think that kind of supply can be a problem for EM.

"We're not at a particularly good moment for emerging markets, although levels this morning are a little bit better following the news about the non-farm payroll number.

More like Aries to come?

"People are worried how this kind of supply from Germany/Russia can effect the market because we've never seen this kind of deal before," added the market source.

JP Morgan this week said it would exclude the bonds from its widely followed EMBI emerging market bond indexes because many portfolio managers are not allowed by their investment rules to buy the securities. JP Morgan said it intends the EMBI to be a benchmark that can be replicated - but added that it will reassess the situation in the fourth quarter.

"Even if it's not included in the index people are still going to buy it because it's Russia. There is not a lot of new supply from Russia out there at this point," the market source said.

The success of this deal may ensure that copycat deals are to follow.

"Now that Germany has demonstrated that this can be done, I believe that late this year we will be seeing other deals like this," noted the market source.

In trading Friday, the Aries dollar-denominated 9.6% bonds due 2014 were at 102 11/16 bid, the euro-denominated 7¾% bonds due 2009 were at 101¼ bid and the euro-denominated floaters due 2007 were at 101.65 bid.

On Thursday, Aires sold €2 billion of floating-rate notes due Oct. 25, 2007 at par to yield six-month Euribor plus 325 basis points.

Aries also sold €1 billion of 7¾% fixed-rate notes due Oct. 25, 2009 at par to yield 7.764%.

In addition, Aries sold $2.4355 billion of 9.6% fixed-rate notes due Oct. 25, 2014 at par to yield 9.604%.

Russia higher

Russian paper was higher on the rally in U.S. Treasuries during Friday's session,

The Russian benchmark bond due 2030 was up 0.188 to 91½ bid. The bond due 2018 was up 1½ points to 127½ bid and the bond due 2028 was up two points at 147¾ bid.

Rompetrol talk

In primary action, talk emerged on Romanian private oil company Rompetrol Group Netherlands NV's planned sale of €100-€150 million of five-year senior notes (-/B-/B-). The yield is expected to be between 10% and 11%.

JP Morgan is the bookrunner.

And market sources told Prospect News that the Hong Kong government is considering issuing a $1 billion bond offering along with the HK20 billion notes. The deal is expected to price in the middle of July.

However, overall it was a sluggish day for emerging markets ahead of the July 4 holiday - observed on July 5 - in the United States.

"It's a very slow day," said a trader. "Not a lot in the pipeline."

Underweight Ecuador, suggests Bernal

Ecuador's political unrest plagued its bonds this week. Despite its paper trading higher on the back of U.S. Treasuries Friday, the political risk remains much too high in the long-term, warned Alberto Bernal, head of Latin American research for think tank IDEAglobal.

"It continues to be a political issue. Unfortunately, the stability of politics in Ecuador does not look good at this point in time.

"That's a very complicated occurrence because with oil prices at such high levels you should have a little more capacity to have a coherent policy framework.

"Unfortunately, president [Lucio] Gutierrez has not been able to achieve it," added Bernal.

There are two main reasons why investors should stay away for the country's credit: first, it succumbed to pressure to raise pension payments, and second, its relationship with the International Monetary Fund.

"President Gutierrez has been obliged to yield to the pressure to increase the minimum pension even though the system is completely broke," Bernal said.

This is yet another piece of evidence that the government does not have the resolve or ability to maintain fiscal policies, he added.

"The pension is really affecting the mood of the market because of the financing. It in not clear how they are going to finance that.

"That implies they are either going to have build up more arrears or use stabilization fund resources and so forth," he said.

The market will not like this because it reduces the chances of debt repurchases - although the scenario of Ecuador buying back debt is highly unlikely.

Another reason to stay away from Ecuador is that the government branches have a very derisive relationship when it comes to setting the country's fiscal agenda, something that the IMF does not look favorably upon.

"In order for president Gutierrez to be able get the support of the IMF, he needs some type of capacity to go to Washington and demonstrate that the congress and the executive are willing and able to work on a sustainable fiscal policy framework, which is, unfortunately, not the case," Bernal told Prospect News.

"We don't like the Ecuadorian story. We remain underweight even though the carry is good and Ecuador is a high beta country. We just don't like the story," Bernal said.

"We are willing to forfeit the return on Ecuador because we have no confidence in the capacity for investors that invest in Ecuador to get good returns because the situation is extremely unstable."

In trading Friday, the Ecuador bond due 2012 was bid at 901/2, up 21/4, while the bond due 2030 was bid at 701/2, up 1.7.

PDVSA will help Venezuelan credit

State-owned PDVSA will be a boon to the Venezuelan market as its transforms itself into a global oil power-house, according to Jephraim P. Gundzik, president of Condor Advisers, which provides emerging markets investment risk analysis.

PDVSA made unexpected news earlier in the week of June 28 when its PDVSA Finance Ltd. subsidiary offered to buy back $2.5 billion and €88.4 million of its foreign debt.

But the announcement led to controversy. Some said the repurchase shows the government's commitment to the capital markets by not investing funds into social programs. Other said the money should be reinvested in the company.

On Thursday, PDVSA asked for an extension in filing with the Securities and Exchange Commission.

"The structure of the company has changed dramatically. Everybody likes to talk about how bad [Hugo] Chavez is and how bad the state is, and to a degree that is true," said Gundzik.

Prior to restructuring by Chavez's government, PDVSA was an extremely poor performer, despite being the largest company in Latin America to be ranked in the top 50 by return on assets and return on investments.

"The main problem with PDVSA's management prior to the Chavez era was that they were extremely self-serving.

"They went to great lengths to keep assets offshore and to minimize the amounts they had to pay as royalties," said Gundzik.

But now the pieces are in place for the company to join the oil elite as PDVSA can tap into its reserves.

"They have the world's largest reserve of heavy oil - the Orinoco belt.

"And when that's converted to light crudes, it can rival the largest reserves in the world.

"And the whole idea is to return investment back to Venezuela," Gundzik told Prospect News.

Venezuela's bond due 2027 was up one point Friday to 86¼ bid and the bond due 2034 was bid at 853/4, up 0.9.

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