Volatile session on confusing data; emerging market debt finishes lower

By Reshmi Basu and Paul A. Harris

New York, April 1 - Despite U.S. non-farm payroll numbers coming in below market expectations, emerging market debt ended the day lower - on a crazy ride in U.S. Treasuries.

One trader blamed the volatility in the Treasuries market for wreaking havoc in emerging markets. When the Treasury market rallied, emerging markets rallied.

"When the Treasury market took a breather, the market came down with it," he said.

"We've seen a roller coaster," in emerging markets. "We've seen about three point moves today [Friday].

"The Brazil '40 were seen as high as 113.90, about as low as 111.20," added the trader.

Conflicting data

Emerging market debt closely tracked the topsy-turvy Treasuries market, which ran amok amidst a set of conflicting economic data in the United States, said sources. By the end of the day, the Treasury market had reversed direction twice during a volatile session.

Treasuries rallied in the morning when the U.S. Labor Department reported that 110,000 non-farm payroll jobs were added in March, half of what was expected. Those numbers helped ease fears that the Fed would hasten the speed of interest rate hikes to 50 basis points from the current quarter point hikes, said sources.

But by mid-morning, the Treasury market reversed direction as conflicting data came in. The Institute for Supply Management's manufacturing index slipped to 55.2 in March from 55.3 in February. But its price index showed a reading of 73 points, up from 65.5 in February, again raising fears of inflationary pressure.

Meanwhile the decline in the unemployment rate in March - part of the jobs report - to 5.2% from 5.4% also fed the inflation fears.

The yield on the 10-year note touched as low as 4.40% before ending the session at 4.45%, down from 4.51% late Thursday.

"I don't think anyone can say that the UST sell-off is over yet," said an emerging market analyst.

"Yes, payrolls were lower than expectations, but unemployment was lower than expected, and the ISM data were strong and showed continued serious price pressures," he said.

Emerging debt lower

The trajectory of price action of emerging market bonds shows how volatile the session was. For instance, at 7:30 a.m. ET, the Brazil bond due 2040 was seen at 111.60 bid. At 10:15 a.m. ET, the bond had moved up to 112.65 bid. At 2:40 p.m. ET, the bond was down to 111.30 bid. At the end of the session, the bond had lost 0.35 to 110.85 bid on profit-taking, said a source.

Other losers included the Brazil C bond, which was bid at 98.812, down 3/8 of a point on the session. The Ecuador bond due 2030 was down half a point to 89 bid. The Russia bond due 2030 was bid at 102.43, down 0.07. The Venezuela bond due 2027 lost 0.30 to 99 bid.

Spreads to widen, says analyst

Friday's numbers provided little direction to the market, as investors are still left wondering where the entry point is.

"People are on pins and needles," said the trader. "They are looking towards the Treasury market for direction. And I think people are getting stuck back and forth. People want to be constructive but every time the market ticks down, they want to sell."

The trader added that, "Argentina continues to feel very heavy."

"The risks are still weighted to U.S. rates going higher, not lower," said the analyst.

"I think that's going to mean EM spreads will have to begin widening again.

"EM spreads may be wider now than their lows in early March, but they are still very tight by historical standards, which means we still have some distance to go in terms of EM spread widening," he added.

"Meanwhile, EM benefited from a brief hiatus in new issuance in the second half of March, but that will end soon as EM issuers - especially corporates - cannot stand on the sidelines forever," he noted.

EM range-bound, says investor

The Federal Reserve is holding financial markets - including emerging markets - captive because no on can pinpoint how it will act moving ahead, said a buyside source.

"The big question is whether the Fed will err on the side of growth or err on side of fighting inflation," he remarked.

"To me, we need more signals from the Fed, instead of trying to read the tea leaves from the data that is coming out and determining whether or not it is growth producing or whether it's inflationary."

Until the markets receive an answer to that question, the buyside source believes that Treasuries will be range-bound, which in turn results in everything else being range-bound.

"Eventually, I think the Fed will err on the side of growth as oppose to the side of fighting inflation. The reason for that is because rates are too low, so if you fight inflation here and then produce a massive slowdown, you are not going to have accommodation left to bring rates down," he predicted.

The buyside source added he believes that the Fed will continue to raise rates by increments, but does not expect to see back-to-back hikes of 50 basis points.

He commented that such a hike is not priced into the market.

"Treasuries are fine the way they are, but what amazes me is that the end of the day that they had rallied again."

The source remarked that when the job numbers are placed in the context of other data in the last month, the numbers give a signal that the U.S. economy has lost momentum. But he also cautioned that too much cannot be based on one number.

"I don't think its 2% growth, but it's certainly reversing that 4% growth that we had last year."

"Now whether that's good bad for emerging markets, I don't think it's entirely bad.

"That doesn't mean that we will see the gung ho gains that we saw last year. I think leveraged players will be a little more subdued because borrowing costs are higher and they are finding themselves range bound and confused."

Furthermore, the source added that the market correction was a positive.

"The fundamentals were good," he said. "The trading and technicals were choppy, so this helps."

He noted that he remains sidelined when it comes to re-entering the market, but he is not necessarily waiting for a lot more data, but seeing how the market acts.

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