Emerging market debt rallies; Ecuador continues decline on political uncertainties

By Reshmi Basu and Paul A. Harris

New York, April 21 - Emerging market debt rallied Thursday on better U.S. corporate bond performance, while Ecuador's bonds continued to fall on political uncertainties after the ouster of its president.

During Thursday's session, stronger credits such as Brazil, Russia and Turkey moved up in the secondary. The Brazil C bond gained 0.938 to 100 3/8 bid while the bond due 2040 rose one point to 114.55 bid. The Russia bond due 2030 added 0.68 to 105.93 bid. Turkey's bond due 2030 moved up 1 1/8 point to 134 7/8 bid.

Meanwhile, Brazilian paper appeared unfazed by the Central Bank's decision to raise its benchmark lending rate to 19½% from 19¼% after market close on Wednesday.

The question weighing on investors' minds is whether this will be the last hike. The bank has now raised rates for eight straight months. Some had expected last month's move to be the last, since economic data was showing a slowdown, said sources.

Now, the market will focus on minutes from the Copom, said an emerging market analyst.

"The Copom rate hike wasn't exactly a surprise, because the local interest rates market began pricing in a higher probability of a rate hike early this week," he said.

"The markets will be looking closely at the Copom minutes when they're released, though, to see whether the Central Bank wants to send any clear signal that this was their last rate hike."

Ecuador continues down

Ecuador's paper fell for a third day on political uncertainties.

With the departure of president Lucio Gutierrez on Wednesday, the market is trying to assess whether or not his replacement Alfredo Palacios will be market-friendly or not.

"Nobody is very excited about Palacios, but at least there is some relief that the Gutierrez resignation went more or less peacefully, said the analyst.

"Palacios reassured the market by stating very clearly that he would not consider default, but his comments about potentially using more of the oil stabilization fund for social spending is unsettling," he said.

"His background as a doctor leaves him as a bit of a mystery, without much in the way of a political record. That's good and bad - he's not beholden to any one political clique, but then again he has no clear base of support, so he'll have to build a coalition in congress from scratch."

However, in a cabinet shake-up, his decision to replace Wall Street favorite Mauricio Yepez with Rafael Correa as economic minister was not well received by the market, said a source. The fear is that "he may not be all that market-friendly," said the source.

Shortly after being sworn in, Correo said the government would get rid of its oil fund (FEIREP) and redirect the funds for social programs and budget purposes, said the source.

In trading, uncertainties pulled down the sovereign. The Ecuador bond due 2012 slid 2¼ points to 94¼ bid while the bond due 2030 fell 3½ points to 79½ bid.

Nonetheless, one buyside source said he thinks the uproar is a "sideshow" at this point. High oil prices may be the country's saving grace and default seems unlikely.

While the source said he owns a little of the paper, he would not describe himself as an active buyer. Despite the political troubles, he said he has held onto to the bonds for technical reasons.

"I don't think it's a credit event either," he remarked.

"As long as oil is fine, they have plenty of revenues. They will be able to service the debt with no problems.

"What the market wants to see them do is more structural improvements as far as paying down debt in the economy. They are being disappointed.

"Does this put them on the path to default? Not if oil is at 40 bucks a barrel. Even at $30, they are probably okay."

Asia still tight, says investor

For the third day this week, emerging market debt has seen "a pretty aggressive rally," commented the buyside source.

"Certain parts of the market still seem kind of heavy. I say that Latins seem very heavy.

"At the same time, the Asians seem very, very tight. I wouldn't want to be short Asian corporates in this environment," he said.

To illustrate how tight Asia is trading, the buyside source told Prospect News about an email sent out by a market participant in Hong Kong Thursday.

"He basically said: It's 12:00 here: I've gotta get some sleep. Here's my cell phone number. I'd prefer you don't use it but it you have these bonds I'm looking for, please call me."

Nonetheless, Thursday's rally was not similar to the rally seen in autos, said the buyside source.

"Everything is up a point or two across the board in the last 48 hours. And it's clearly squeezing the market.

"And what they say about Asians, once the momentum gets going, that's a hell of a trade."

While the secondary appears to have picked up, the rules of the game are changing in the primary market.

"The market is functioning. But I don't think this is the environment we were at in January, when you could bring any deal at any price and get it done. The market is being very selective, remarked the buyside source.

"Deals that are priced properly trade well - they don't go down," he said.

The buyside source said that when he is considering new deals, he is being more selective when it comes to credit quality.

"That's not saying that we won't buy single-Bs or triple-Cs, but we really have to believe in the story. And likewise, just being very sensitive to pricing.

"I'm like everyone else who bought stuff that was over-priced in March and watched it go down 10 points."

The buyside source remarked that 2005 will look very similar to 2004 "but we don't have the upside that we had last year."

While the credit cycle is moving along and fundamentals are good, higher interest rates rise mean less returns in emerging markets, he noted.

"I don't expect to see big defaults. But nevertheless, it's not like we started off the year yielding 7½%. It's not like we're going to go to 5½%. If we get back to 7½%, that's a win.

"That's true if you are looking at high yield or if you are looking at emerging markets," he remarked.

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