Brazilian debt slides; rising commodity prices seen lifting Latin America

By Reshmi Basu and Paul A. Harris

New York, April 15 -Brazil's bonds took a beating in secondary trading Thursday on expectations that a Fed hike will come sooner than later.

In late afternoon, the Brazilian benchmark C bond was bid at 93.188, down 2.375. The bond due 2040 was bid at 97.75, down 3.5.

A senior sell-side official said that the 2040s were down as much as much as four points during the day, but had a slight rebound.

"Brazil is down massively today,

"On a spread basis, Brazil is about 55-60 basis points wider today."

The plunge flies in the face of earlier investor sentiment that Brazil's $5 billion amortization pay-off would be plowed back into the market. Now potential U.S. interest hikes are culminating in risk aversion.

"It's funny because there were big coupon payments coming into the market today, mainly from Brazil," said the senior-sell side official. "And you would think that the reinvestment of some of that stuff would help support the market.

"With Treasury yields having widened in the last week or so, some of the lower price is attributable to Treasuries. But the spreads [on Brazilian paper] are also substantially wider," added the senior sell-side official.

Time to sell Brazil, says BofA

Meanwhile, analysts at Banc of America said it may be time for investors to reduce exposure to Brazil.

The Brazilian component of the Emerging Market Sovereign Bond Index has fallen 3.36% year to date, underperforming the 1.30% emerging market debt benchmark by 476 basis points, analyst Callum Henderson said in the firm's Situation Room Report.

That is far from last year's return of around 65%, bolstered by massive spread tightening, strong policy implementation, improving credit quality and positive global liquidity conditions, said the report.

Henderson expects a disappointing economic recovery for Brazil this year. Its GDP growth is predicted to be 2.4% in 2004 versus negative 0.2% in 2003.

Political noise, such as the Jose Dirceu Bingo-gate scandal, may have gone far to paralyze the government's ability to push through policy decisions.

The increasing public outcry on austerity program and waning support for President Luiz Inacio Lula da Silva will make it more difficult to consolidate economic policy.

"The real test of the 'improving fundamental story' theory for Brazil will come when global excess liquidity is eliminated and the Fed starts hiking interest rates," said Henderson.

The report recommends that both dedicated emerging markets funds and crossover funds should continue to "substantially" reduce their Brazilian exposure.

"With coupon/amortization related demand set to decline significantly from May to September and dedicated EM funds still very overweight the technicals look poor while the fundamental picture is starting to look more challenging."

For leveraged funds, the analysts recommend shortening duration, "buying the front end of the curve against '40s as this has underperformed so far this year and looks relatively cheap by comparison."

Venezuela's floaters seen aggressive

Coming up, the Bolivarian Republic of Venezuela will auction $1 billion floating-rate notes due April 2011 on Friday via Dresdner Kleinwort Wasserstein and UBS Investment Bank.

Because Venezuela has capital controls, not all the money is allowed to leave the country.

"As a result the Venezuelans target the deals locally and sell them at very aggressive interest rates compared to the rates at which they could sell them on the international market," said the senior sell-side official.

The government is able to do this because they have a two-tier exchange rate system.

"They have an official exchange rate, which is lower. But then because of the capital controls there is a parallel rate, or a 'black market' rate, which is much higher," said the senior sell-side official

"Because there are capital controls, if you do want to buy dollars on the black market they cost you a lot more.

"So they effectively subsidize the purchase of foreign exchange to buy these dollars because they let the investors buy the dollars at that official exchange rate, which is the only way they can buy dollars at the official exchange rate," the senior sell-side official added.

"And in exchange for the right to buy dollars more cheaply than they could otherwise buy them they are willing to buy these bonds at a below-market interest rate."

Pricing for this Regulation S deal will take place on April 16.

And according to the senior sell-side official Russia's natural gas giant OAO Gazprom's big $1.2 billion note offering will fetch investors.

"I think that will go well when it comes because we haven't really had any Russian corporate supply in a while other than a little bit of bank paper."

And India's Reliance Industries $750 million bond due 2009 via Credit Suisse First Boston and ABN Amro may be a no-show.

"People have been saying that Reliance is going to get done as a loan instead of a bond. I think that was mandated back in October," said the sell-side official. So if it's still a bond it's been waiting a long time."

Commodities boost emerging markets

Emerging markets have benefited from rising commodity prices.

"Oil exporters such as Mexico, Venezuela, Russia; even Brazil are basically self-sufficient, now. So higher oil prices help our market, net-net," said the senior sell-side official.

"And we have a lot of producers of copper and iron ore.

"But you have to keep in mind that some of this pricing power has been in place for a while. It's not as if it just started happening now," added the senior sell-side official

However, some investors are cautious about the assumption that commodity prices are going to continue to remain so high. In the case of China, commodity prices may not stay as high if that country's economy slows.

"Some of them are high because of China. And people are thinking that China will either slow down somewhat or the Chinese will actually engineer a slowdown; that it's a bubble, and if they don't slow it down in a managed way the bubble will burst," added the senior sell-side official

"And with regard to steel, it's true that China has been importing significant amounts of steel. But everyone expects China to bring significant new steel production capacity of their own on line over the next couple of years, which will reduce their import needs," added the senior sell-side source.

"In the meantime, their economy is going to continue to grow, which would seem to support continued high commodity prices. But investors are cautious with regard to the China story."

And rising commodity prices have been a boon to Latin American countries, according to Alberto Bernal, Latin American economist at financial markets analysis firm IDEAglobal.

Copper has bolstered Chile's already strong fundamentals. March exports of Chile increased $1.4 billion, 175% increase from March 2003.

"When you have such an important increase in size of exports of a country, you will have two things: more capacity to import goods that will generate higher economic growth and the second thing, a much higher level of surplus on the commercial account," Bernal told Prospect News.

"The country will become not an international debtor but an international capital generator. The current account of the country will turn to the positive side.

"That's very important because it reduces the vulnerability of the country to external shocks," he said.

"Everything else equal, if you have a positive current account and you own Chilean debt, the risk of Chile not paying you is very low because the money is there."

Therefore, the interest rates on the bonds tend to fall.

This holds true for every single country in Latin America, since every county is dependent on exports of commodities, said Bernal.

And markets have rallied significantly on the expectation that this would happen, explained Bernal.

"One of the reasons why Brazilian assets were in such demand last year was because everyone was seeing the phenomenon of moving into positive relationships in terms of indebtedness of the country, in terms of the current account balances and so forth. People were realizing that this high level of trade surplus will take place because of the trends that we were seeing on commodity prices."

And Bernal says the rise in commodity prices will soften the blow of a Fed hike.

"The good news is if that increase on interest rate is somewhat constrained, meaning that it goes up in an orderly fashion and there is no violence in the market, there's no huge moves one way of the other," said Bernal.

Higher commodity prices will improve the fiscal situation, making the external position better, and reducing the interest of some investors, not everyone, to get out of the position in the external market.

"High levels of commodity prices are an insurance for the region and it should help ameliorate the negative effects of the hike in U.S. interest rates," added Bernal.

Coming up PT Bank Negara Indonesia is expected to bring $200 to $300 million offshore bonds to market. Pricing is expected in late May.

And out of Thailand, petrochemical company PTT PCL is planning $500 million global bond offering, via Deutsche Bank Securities and JP Morgan.

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