Emerging market debt sees mixed session; Turkey recovers

By Reshmi Basu and Paul A. Harris

New York, June 27 - Emerging market debt saw a mixed session Tuesday on the back of weaker U.S. equity markets.

The tone across emerging market debt somewhat improved after Monday's late afternoon sell-off, but was nonetheless negative as the clock ticks down to the Federal Reserve's rate hike decision on Thursday.

Tuesday saw Andean countries as among the worst performers in the asset class, as those credits followed U.S. stocks lower, according to a market source. Moreover, Turkey's fundamental woes continued to exercise some influence over the Latin American region, noted a trader.

Since last week, the external debt market has seen spreads widen on concerns over Turkey's ability to finance its sizable current account deficit as global interest rates churn higher. As a result, emerging markets have ticked lower as the contagion effect grabbed hold of Latin America and other markets in recent sessions.

Emerging market currencies, especially in Eastern Europe and in particular the Turkish lira were slammed late last week, according to a sellside source.

The ongoing devaluation of the Turkish lira has sparked a round of spread widening for the country. The lira has lost nearly 25% of its value in recent weeks. And as positions in Turkey's sovereign debt began to unwind, so did the rest of the external debt market.

On both Monday and Tuesday, Turkey's central bank intervened to sell dollars after raising key interest rates this weekend in hopes to halt the sliding lira. The central bank has raised rates by 400 basis points in a span of two-and-a-half weeks. That move is sizable enough to have somewhat filtered into Latin America's performance, according to the sellside source, but the source noted that Latin America was not hit hard.

On Tuesday, the Turkish lira saw a slight rebound on the back of the central bank's decisions, which gave some support to Turkey's sovereign bonds. During the session, Turkish bonds stopped the recent bleeding as the country's bond due 2030 gained 0.50 to 132 bid, 133 offered.

Nonetheless, Turkey continued to influence other Latin American debt markets as high beta credits remain under pressure.

Argentina, Colombia and Venezuela were weaker on the day. At session's end, Venezuela saw its spreads kick out by 16 basis points.

Brazilian bonds saw more stability Tuesday, but then gave back gains in the late afternoon as equities ratcheted up losses. Volumes were thin as local markets closed shop for the World Cup match between Brazil and Ghana.

However, short selling and hedging appear to have subsided in Brazil's local markets, which is helping the market regain some stability, according to Enrique Alvarez, Latin America debt strategist for IDEAglobal.

During the session, the Brazilian bond due 2040 lost 0.60 to 121.20 bid, 121.45 offered.

Overall, the JP Morgan EMBI Global index was wider by three basis points versus U.S. Treasuries. Returns were down 0.2% on the day.

Eyes on Fed

Meanwhile the market is focusing on two issues: the Fed's decision on Thursday and those credits suffering from large deficits, noted market sources.

Despite the recent market turbulence, emerging markets external debt is not in panic mode, noted the sellside source.

Even though the asset class has been softer over the past couple of days, "it's not that bad," on a spread basis, remarked the source, adding that the 10-year spread on the Brazil sovereign is a decent indicator that the market is surviving.

The source observed that the spread has been trading back and forth in a range of approximately 15 basis points and given the broader market backdrop that is not such a bad move

"The corporates have gotten softer, lately, and have been leaking a little more. But we've never been to the point where we have seen panic-selling," noted the sellside source.

Market tracks lira

In particular the performance of the external debt market has been somewhat beholden to the devaluation of the Turkish lira, noted market sources.

But as one analyst put it, the Turkish headlines have trumped local "positive" headlines in determining the performance of local markets.

"Just as an example, the Turkish story has become more important to assess the expected performance of the Colombian peso than the expected trends on foreign direct investment on the back of the free trade agreement with the U.S.," wrote Alberto Bernal, fixed income analyst for Bear Stearns & Co, Inc, in a research note.

"The logic of expecting financial contagion between Colombia and Turkey is non-apparent, among other things because there is barely any financial/economic relationship between these two countries, outside of the fact that the two countries are part of the universe of emerging markets," he said, noting that Colombia's current account deficit of 1.5% of gross domestic product is much lower than Turkey's 7% of GDP.

Energisa changes structure

In other news, Brazilian utility company Energisa SA revised the structure of its impending bond offering (/B+/BB-), according to the sellside source.

Energisa had originally sets its eyes on selling perpetual bonds at a size of up to $250 million. The tenor was then changed to 10 years. The sellside source noted that there were whispers of 9½% guidance on that issue late last week.

But once again the maturity has changed, this time down to seven years for a deal that is expected to be slightly smaller than $250 million.

"Now you're hearing 10% for seven years, for a slightly smaller deal, reminiscent of what is going on in high yield," noted the source.

Energipe SA and Saelpa SA will issue the bonds while holding company Energisa will guarantee the offering. Merrill Lynch is the bookrunner.

That seems the only deal in the pipeline, according to sellside source, who added that most issuers are waiting on the sidelines for a better market.

"In emerging markets, as opposed to the high-yield market, you don't usually see issuers who have a gun to their head to issue.

"Most emerging markets primary issuance has stopped, whereas in high yield you have Nortel and Windstream and Intelsat that all have to get deals done, and will pay up very substantially to get them done," noted the source.

Emerging markets issuers are not as likely to pay up 50 basis points or 100 basis points more than they would have a week ago to get the deal done. There may be a point when the issuers will succumb but for now, emerging markets issuers are inclined to wait out the storm. On top of that, most sovereign issuers prefinanced this year ahead of the election year.

Mexico tightens

In other developments, Mexico saw its spreads tighten leading up to next week's presidential election. Manuel López Obrador, the left wing candidate, has been ahead in the polls, so the likelihood of him prevailing has been priced into the market.

Nonetheless, there is no certainty that he will win, although he has led opinion polls over the past month or so.

"If he wins by a landslide it could be bad because he may feel as though he has more of a mandate," noted the sellside source.

On some days the Mexican stock market has been underperforming. On Tuesday, it was spotted down 2.5%, whereas Brazil fell 0.7%.

"That has been true on a few other days. But if you look at the bonds you would not necessarily feel that was the case," replied the sellside source.

The Mexican component of the JP Morgan EMBI+ was spotted tighter by six basis points to 148 basis points versus U.S. Treasuries while its portion if the EMBI Global index was tighter by four basis points.

The source added that in general external debt has held in pretty well.

"It's the local currency-denominated debt that has gotten hit, where a lot of inflows to emerging markets over the past six months to 12 month have gone, as well as into equities, obviously. Local rates are widening out substantially. Exchange rates are depreciating.

"Investors who went into local currency-denominated debt - which is of course a place where the hedge funds are especially big - are hurting," the source told Prospect News.

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