Emerging market debt dips ahead of FOMC; Brazil to sell $9 billion bonds in next 2 years

By Reshmi Basu and Paul A. Harris

New York, Aug. 8 - Emerging market debt saw a slight market correction ahead of Tuesday's Federal Open Market Committee meeting as U.S. Treasuries moved into a defensive position.

"Prices have been a little lower," said a trader.

"Spreads are a little bit wider. Volumes are probably on the lighter side."

The trader noted that the market came down a bit after last week's positive run where spreads hit record tights and prices were up.

"Today [Monday], we're giving some of that back."

In late trade, the JP Morgan EMBI+ Index was lower by 0.49% while its spread to Treasuries widened by three basis points to 279 basis points.

The Brazil bond due 2040 was spotted at 117.301 bid, 117.648 offered late in the day, down 0.429.

The trader added that the market has already factored in the Fed's expected 25 basis point rate hike. And that anticipated move had little influence on Monday's trading session.

"I think our market has had a pretty good tightening last week," which inspired a bit of a market correction, he added.

In another development, Ecuador's bonds plunged following the resignation of finance minister Rafael Correa. Deputy finance minister Magdalena Barreiro is expected to be sworn in as his replacement.

"The finance minister who got the boot last week is more popular than the president," according to a debt strategist.

A trader said the Ecuador bond due 2030 was nearly down 2½ points on the session.

Rate hike expected

Meanwhile, investors are not nervous ahead of what is expected to be the 10th consecutive rate hike by the Federal Reserve, said the debt strategist.

The Fed is expected to lift the federal funds target rate to 3½% Tuesday afternoon.

"Because they are moving tomorrow [Tuesday], it pulls people's attention back to the Fed call," commented the strategist.

Since the last FOMC decision on June 30, there has been a series of strong economic data in the United States, he noted. The last of item was Friday's non-farm payroll number of 207,000 jobs created, which came in stronger than expected.

"The economy is humming along. And there is no reason to think that the Fed isn't just going to raise rates for a while. People are now going: hmm.

"The futures have actually corrected up to 4% for fed funds at the end of this year. People are talking about 4¼%," added the strategist.

He also remarked that Goldman Sachs announced Monday morning that the FOMC would likely raise its target for the federal funds rate to 5% by the middle of next year.

Higher rates pose risk

Furthermore, volatility for emerging markets is coming from the Treasuries side, and not so much from within the asset class.

"It's all Treasuries. It's Treasury, Fed, Fed, and Treasury. I don't think it's on EM local, specific governments. I think it's all about the spread duration in your portfolio."

"It's about how the market is feeling. I think right now the market is feeling that yields are going up," noted the strategist.

Meanwhile U.S. Treasuries were on the defensive ahead of Tuesday's Federal Reserve meeting. The yield on the 10-year note rose to 4.42% from Friday's close of 3.39%.

Brazil to sell up to $9 billion in global bonds

The Federative Republic of Brazil (B1/BB-/BB-) is planning to raise up to $9 billion between now and the end of 2007 to meet its funding needs during that time period, according to a market source.

One capital markets source on Monday told Prospect News that although most sovereign issuers have met their 2005 funding needs Brazil is thought to be a candidate for bringing more issuance on the international bond market before the close of the present year.

The source added that one mitigating factor is the ongoing political scandal in that country, in which Brazilian President Luiz Inacio Lula da Silva and other senior officials are enmeshed. Until the negative news dies down, the source said, Brazil may elect not to approach the international capital markets.

According to data compiled Prospect News, Brazil has priced nearly $5 billion and €500 million of sovereign bonds thus far in 2005.

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