Tame CPI does little to ease investors' inflation worries in volatile session; Brazil C bond to be called?

By Reshmi Basu and Paul A. Harris

New York, Feb. 23 - Emerging market finally finished Wednesday's session stronger, helped by a tame consumer price index report in the United States and a strengthening dollar. But the trading day was far from calm and breezy, as both buyers and sellers came to the market.

The increase in the core CPI was below expectations, coming in at 0.2%. The market had priced in a high reading, fueled by Friday's surging PPI numbers in the United States. Those PPI numbers coupled with a weak dollar prolonged Friday's sell-off into Tuesday.

The dollar, which was clobbered Tuesday on stories that South Korea planned to sell U.S. dollar assets, retraced some losses as Seoul's central bank denied the report.

Nonetheless, Wednesday's CPI numbers were not enough to completely ease inflation worries looking ahead. If anything, the numbers served as a temporary bandage for a lingering concern.

"USTs jumped in the first few hours after the CPI release, but I think as the day went on everyone realized that it's going to take a while for the big jump in January core PPI to feed into CPI," said an emerging market analyst.

"And with oil prices still trading above $50/bbl and some people talking about re-testing last year's highs, the inflation story is going to stay on the front burner.

"There's also plenty of wholesale inflation left in the pipeline, and not just from oil. The CRB commodities price index is back to trading at all-time highs, with copper, coffee and other commodities at or near their highs from last year. All this spells trouble for rates and for EM," he added.

Initially, U.S. Treasuries rebounded on the benign inflation numbers, but turned back some of those gains based on a cautious picture for inflation painted by Atlanta Federal Reserve president Jack Guynn.

The yield on the 10-year note was down to 4.27% from 4.30% at Tuesday's close.

In trading Wednesday, emerging market debt took its cue from the Treasury market.

"It [emerging market] was a little bit better today [Wednesday]," said a trader. "It was mixed and we had an up and down trade.

"The tone seems bad at times - then right after we have a little bit of downtrade, it comes right back," he noted. "Tough to figure out these days."

Volume was decent during Wednesday's session, with locals and institutions both buying and selling.

"The market is waiting for an event to sway it one way or another," commented the trader.

Nonetheless, emerging market debt saw a mixed day. After the release of CPI numbers, paper was bid higher. As the day carried on, it retraced some gains. At late morning, the Brazil C bond was spotted at 102½ bid, up 0.312. The Ecuador bond due 2030 was quoted at 93¾ bid, up 11/2. The Russia bond due 2030 was spotted at 105½ bid, up 5/8.

By the close, the Brazil C bond was down slightly a 102.12 bid, off 0.068 while the bond due 2040 was bid at 116.2, up 1.2. The Ecuador bond due 2030 closed the session at 92.80 bid. The Russia bond due 2030 was bid at 105.18 bid.

C bond might be called

A market source said that the recent strength in the Brazilian real increases the possibility that the government will call its C bonds in April.

"There are rumors that Brazil will call its C bonds at the next call date, which is April 15, although they would need to notify bondholders by March 15," the source said.

A buyside source noted that every time investors approach the call date, speculation starts coming of the woodwork.

"It makes sense if they are going to refinance it, but an outright buyback doesn't make sense to me," said the buyside source.

According to the buyside source, the amount runs around $7 billion, which would be 15% to 20% of the country's reserves.

"Brazil's international reserves have been rising, which increases the chance that there will be a call," said the market source.

"If they make the call in whole, which would seem to be the most prudent thing for them to do, Brazil's international reserves and cash balance would drop by $6 billion equivalent."

"Right now, however, it is conceivable that they could make the call without immediately issuing new debt. And in that scenario you would expect a rally to ensue in Brazilian debt because of the dramatic drop in supply.

"Whether or not they issue in conjunction with a possible call, Brazil still needs to issue $2.5 billion this year in order to prefinance some 2006 obligations.

"Keep in mind that Brazil's decision to call the Cs will be made against the backdrop of rising rates in the U.S. They must decide if circumstances will be as favorable when the next call date comes around in October," the market source told Prospect News.

Argentina's debt offer may be successful

Argentina's debt swap comes to an end of Friday for over $102 billion of defaulted debt. The market is now hearing 70% to 80% participation from locals, said the strategist, a winning rate for the government.

"We did not expect that high of the number," the strategist said. "We thought 60% to 65%, which would be a success. Going to 70% to 80% is an achievement, from the view of Argentina."

Argentina is expected to tap the market soon with a peso-denominated issuance, said another market source.

In other news, Ecuador said it plans to issue $200 million in five-year bonds, $100 million in eight-year bonds and $450 million in 10-year bonds, according to a source.

The country's central bank set an annual fixed coupon of 9½% for the three-tranche offering.

Another buyside source said: "No clear details from the Street yet."

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