Emerging market debt stages comeback on Brazilian minister's comments; Ecuador down on oil protests

By Reshmi Basu and Paul A. Harris

New York, Aug. 22 - Emerging market debt staged a comeback Monday after Brazilian finance minister Antonio Palocci said he would remain at his post.

On Friday, Brazilian markets were rattled by allegations that Palocci received kickbacks when he was the mayor of Ribeirao Preto.

In a press conference held on Sunday, market-friendly Palocci denied any allegations of wrong-doing. He also added that Brazil's economic policy would not be altered.

That assurance helped lift Brazilian paper Monday. During the session, the bond due 2040 was at 117.70 bid, 117.95 offered, up 0.65.

"I think the market took his statements yesterday [Sunday] as a positive," said a buyside source, adding that the sentiment could be short-lived given how the headlines come and go.

"For the time being, the market took comfort that he came out immediately. But again as he said and he reassured the market, the economic policy in Brazil is not going to change even if he does not stay on," said the source.

In doing so, he prepared investors for such an event, even though at the moment it appears that he will remain part of the government.

A departure would usher some volatility but the buyside source noted: "Eventually investors would realize that policy is not likely to change."

Meanwhile the source gave a mixed review as to how president Luiz Inacio Lula da Silva's Workers' Party is dealing with the three-month old corruption scandal.

"The PT and Lula could have done a better job. It is only now that they realize that they need to be proactive."

The scandal will likely linger for a few more months, as the graft probe seems to have many legs.

"As proven by what happened on Friday, I think there is a lot of potential for unexpected surprises here and there - maybe not all of them with a real foundation.

"It's going to be a bumpy ride. And then we get into election season next year," replied the source.

Ecuador down

Meanwhile Ecuador's debt continued to lose ground.

Talks have started between protest leaders and president Alfredo Palacios' government. Last Friday, Ecuadorian bonds fell after protests by striking workers in two oil-rich provinces shut down the export of crude oil.

During Monday's session, the Ecuador bond due 2012 was down 1.45 to 97¼ bid.

Positive tone in EM

Despite the volatility in Brazil, the market has exhibited a good tone, said sources.

"It's hard to get too optimistic or too pessimistic because liquidity is kind of low," said the buyside source.

With so many participants out on vacation, the source added that investors are cautious about making too many trades "since people are scrambling to cover their desks."

"Once September comes, we are going to see a bit more directionality. Probably people have already reduced positions ahead of leaving for their vacation.

"Everybody is probably in a comfortable spot right now."

Furthermore, the buyside source added that there has probably not been a significant reduction in exposure, given that it is difficult to give up the "gain in carry."

However, the source added that reductions have occurred in more volatile names such as Brazil.

"In Brazil on Friday, the flow was quite significant. The short in the U.S. dollar versus the Brazilian real in the currency market has actually been reduced...from 5 ½ billion to 4.

"There's been some reduction going on," noted the source.

Oil edge higher

U.S. crude oil inched higher Monday, gaining $0.10 to close at $65.45 a barrel. As oil prices near $70 a barrel, people are paying attention, said a trader who focuses on Asian credits.

Thus far, it has been pretty easy to ignore the threat of inflation because of how flat the yield curve is, "...but the rising oil price has people wondering whether or not proper inflation expectation are priced in at this point," said the trader.

"People had been looking at the shape of the [U.S] Treasury curve and thinking 'If the Treasury market isn't worried about inflation I guess I won't be.'"

"Now with this big gorilla in the corner - i.e. oil - it's tough to continue to follow the 'ignorance is bliss' principle.'"

Heavy issuance pipeline in September

While the primary market has shut down in August, September promises to be a busy month for the primary market. It's typical at this time of the year for issuers to take a hiatus because much of the buyside and sellside is gone for at least a part of August, noted the trader.

"You always get the specter of a fat calendar in September. People worry about it in August and spreads widen out because of that expectation."

The buyside source added that it is too soon to tell whether new supply will weigh down the market.

"From evidence that we are getting from the inflows that are coming into the asset class, it seems that it is going to exceed the supply. So in the worse situation, the supply will be absorbed.

"End of the year has always been a period when money flows into the asset class," said the buyside source, who added that the fourth quarter traditionally sees a pick up in flows.

Looking ahead, the trader remarked that he is hearing that there will be quite a few Chinese high-yield deals and a handful of Indonesia high-yield deals tapping the capital market.

He said that he is not expecting any material sovereign issues.

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