Emerging market debt consolidates ahead of Fed meeting; Brazil sells downsized €300 million add-on

By Reshmi Basu and Paul A. Harris

New York, Jan. 30 - Emerging market debt saw a pullback Monday in light trading, a day ahead of the Federal Open Market Committee meeting.

In the primary market, Brazil reopened its 7 3/8% bonds due February 2015 (Ba3/BB-/BB-) to add €300 million in a drive-by.

Perhaps most startling given recent strong demand and expectations of relatively low new issuance this year was that the deal was downsized from €500 million.

Barclays Capital and Dresdner Kleinwort Wasserstein were the lead managers.

One source described the book building process as a tug of war between investors and Brazil, adding that he was surprised that the size of the issue was decreased.

"What I heard was they were trying to build the order book all day, at about noon New York time, they still only had a little more than €300 million and decided to just go ahead with that amount.

"Brazil had apparently pushed for a very tight spread, DB had gone along with that, and it just didn't work," he added.

Moreover, Monday's sell-off, the overhang from heavy issuance earlier this month, and U.S. Treasury weakness all looked like they played a role.

But he added that Brazil could have placed the full €500 million if it had given up a little extra spread.

The deal priced at a spread of 185 basis points over mid-swaps, in line with talk. The add on was marketed at a 5 basis point discount to the existing bid side on the bonds.

With a 7 3/8% coupon, the bonds priced at 113.428 to yield 5.45%. The original €500 million came at 98.80 on Jan. 20, 2005 to yield 7.55%.

Late last year J.P. Morgan analysts forecast that Brazil will issue $4.5 billion of debt during 2006.

EM consolidates

Financial markets were nervous Monday ahead of Tuesday's Fed meeting at which the central bank is expected to raise short-term rates by 25 basis points to 4½%, the 14th straight increase.

U.S. Equities markets and Treasuries turned lower as the yield on the 10-year note rose to 4.53% from Friday's 4.50%. And volatility in those markets finally caught up to emerging markets.

The asset class trudged lower on the back of the Treasury dip.

"It's pretty slow today [Monday]," remarked a trader, who added the slowdown is most likely a function of the lunar holiday in Asia, the Fed meeting and Friday's release of job numbers.

Furthermore, he said that the market was "consolidating in most places" - but he added that Argentina outperformed. He described Monday's trading volumes as below average.

Another source noted that Ecuador was also an outperformer on the back of higher oil prices and a positive outlook from Standard & Poor's.

During the session, the spread on the Argentina discount bond due 2033 tightened two basis points.

Meanwhile the Ecuador bond due 2012 was up ¾ point to 103.30 bid, 104¼ offered. The bond due 2015 gained 1.40 points to 100½ bid, 101 offered while the bond due 2030 added 0.90 to 97¼ bid, 98 offered.

The benchmark Brazil bond due 2040 shed 0.45 to 129¾ bid, 129.90 offered. Brazilian corporates were marginally softer on the Brazil dip, noted an emerging market analyst.

Elsewhere, the Russia bond due 2030 lost half a point to 111¾ bid, 112 1/8 offered. The Venezuela bond due 2027 fell 0.30 to 125¼ bid, 125.60 offered.

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