Emerging market debt sees volatile session on wild Treasuries ride: Philippines sells $1 billion bonds

By Reshmi Basu and Paul A. Harris

New York, Sept. 7 - Emerging market debt saw a volatile session Wednesday as U.S. Treasuries took a licking in response to hawkish comments by a Federal Reserve regional president.

In the primary market, the Republic of Philippines priced $1 billion of bonds due 2016 (B1/BB-/BB) at 98.301 to yield 8¼%.

The drive-by deal was increased from $750 million and came at the rich end of initial price guidance for a yield in the 8 3/8% area.

Citigroup, Deutsche Bank and UBS Securities were lead managers.

And Thailand's G Steel Public Co. Ltd. mandated UBS Securities as the bookrunner for an offering of five-year bonds (B1/B+).

Treasuries bring down EM

Higher Treasury yields meant a rocky session for emerging markets, sources said.

"Today [Wednesday] started out like it was going to be... quiet," said a trader.

"But we actually got a little bit of volatility here, especially with how the Treasury market acted today [Wednesday]."

"The five-year auction was good but the Fed statement turned the market down. We [EM] closed lower on the day," remarked the trader.

The Treasury market turned sour as indications of inflationary pressures in the U.S. economy resurfaced.

Chicago Fed president Michael Moskow said that the Fed would need to make "a number of judgment calls" in assessing the impact of Hurricane Katrina. Additionally, he hinted that the Fed would continue with its strategy of measured interest rate hikes.

"I'm concerned about core inflation running at the upper end of the range that I feel is consistent with price stability," Moskow said in a speech to the Futures Industry Association.

Speculation that interest rates would continue to move up pushed Treasury yields higher. The yield on the 10-year note closed at 4.14%, up from 4.09% at Tuesday's close.

That helped drive emerging market debt prices down.

"Brazil and Argentina are pretty much the two things that are trading right now," observed the trader.

During the session, the Brazil bond due 2040 lost 0.30 to 119½ bid. The Argentina bond due 2009 lost one point to 32½ bid.

"[Brazilian] prices are holding extremely well if we take into account the correction that we have seen in Treasuries," observed a Latin American debt strategist at Refco EM.

Meanwhile the Russia bond due 2030 slipped 0.32 to 114.12 bid. The Turkish bond due 2030 fell a quarter of a point to 143½ bid.

Colombia outperforms

The trader added that Colombia was the biggest outperformer on the day in response to news that it would buy back $700 million of dollar- and euro-denominated bonds via a modified Dutch auction.

"It made sense for them to take back some of their high coupon paper," said the trader. "The only thing that was surprising was the issues that they took. It wasn't all short end or long end. It was kind of like throughout the curve."

"It makes sense for them to take back some of this paper and reissue locally or whatever they are going to do with the money," he added.

During the session, the Colombia bond due 2033 added 0.60 to 124¼ bid.

Oil producers down

Oil producers were down in trading Wednesday as oil prices retreated Wednesday. Light sweet crude for October delivery dropped $1.59 to close at $64.37 a barrel on the New York Mercantile Exchange.

Venezuela was down between 50 to 75 basis points in different parts of the curve, commented the strategist. Ecuador's bond due 2012 was down about 25 basis points while the bond due 2030 was lower by about 100 basis points.

"What we've seen in the past few days is that there was a very high correlation among these oil producers and the price of oil," he added. "If oil comes down, oil producers will see a type of correction."

"I don't foresee oil reaching the $30 handle in the next few months. At $30, Venezuela, Ecuador and Mexico are making enough money to meet their maturities.

"There is a very, very important amount of money that is being made by these countries. I think it is diminishing the overall risk on their debt," observed the strategist.

Hurricane effects

After the devastating Hurricane Katrina, the market at first took the view that the Federal Reserve would take a break in its current monetary tightening campaign, according to the strategist.

Additionally, a flight to quality helped move the 10-year note to a level that was initially unexpected, he added.

The market will now turn to the Federal Reserve meeting to be held on Sept. 25. The market will closely watch the language and look out for any other clues as to what direction the Fed will take in the aftermath of Hurricane Katrina.

"The Fed is in a very tight situation," said the Refco strategist.

"They need to choose between inflation and growth. They have expressed before that the principal role of the bank was to control inflation.

"But I think this situation is by all means a different type of a shock," he noted.

Furthermore, the trader said that investors were in a holding pattern until the Fed's decision. Emerging markets were "hanging around with Treasuries," he added.

"No one is taking bets one way or another. Everyone is waiting to see what the Fed will do later on this month. And then we will go from there."

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