Emerging market paper ends lower on profit-taking; Brazil 2040s hit; Mexico 2034s underperform

By Reshmi Basu and Paul A. Harris

New York, Sept. 24 - Emerging market debt fell Friday as profit-taking hit the market, with investors cashing in on the recent rally.

"Most of the flows were in Brazil - Brazil '40s," said a buy-side source.

"A lot of your money accounts and hedge funds putting some shorts on.

"We were bound to have a little bit of consolidation here after the rally," said the source.

During the session, Brazil's bond due 2040 fell a point to 111¾ bid while the C bond lost 0.188 to 98 5/8 bid.

"There's been profit-taking and a little bit of a breather in terms of what we saw last week and what we saw at the beginning of this week," said a Latin American debt strategist at Refco EM.

"I don't think this comes as a surprise," he said.

Paper from Mexico and Russia also traded lower. The Mexico bond due 2008 fell a quarter of a point to 114.65 bid. The Russia bond due 2030 was bid at 97, down 0.688 on the day.

Overall, emerging market debt was down. The JP Morgan EMBI+ Index slid 0.10%. Its spread to Treasuries narrowed one basis point to 424 basis points.

But Friday's sell-off is a temporary glitch, given that the conditions are the same, according to the buy-side source.

"Nothing has necessarily changed fundamentally in U.S. Treasuries.

"Unless something happens on that front, we are going to be trading in ranges," said the source.

"Every time people feel that we've rallied quite a bit, there's going to be profit-taking."

Looking ahead, investors will be paying close attention to the International Monetary Fund annual meeting to be held Oct. 1-3. Investors will look for clues as to what market sentiment is, according to the buy-side source.

"A lot of people are going to try to be neutral until then.

"I think that will be the major event coming up next week, and that will give direction to the market," added the source.

Mexico down on central bank hike

Mexico's debt suffered Friday as the country's central bank lifted interest rates for the sixth time this year in a bid to rein in inflation. The borrowing rate was hiked to 51 million pesos day from 45 million pesos. The market was expecting an increase in the corto after Thursday's release of much higher than expected inflation figures for the first half of September, according to the strategist.

"That put pressure on the short-term interest rates and also on the longer part of the curve," he commented.

For the day, the Mexico bond due 2016 lost one point to 146 1/5 bid while the bond due 2026 was also down a point to 150 ½ bid.

The increase also hurt Mexico's newly issued 30-year bonds, according to the buy-side source.

The 2034 issue traded at 220 basis over Treasuries Friday, out 10 basis points from the 210 basis points spread it priced at on Wednesday.

On a price basis, the new bond was quoted at 96.85, 1½ points lower than its issue price.

On Wednesday, Mexico priced $1.5 billion of 30-year bonds at 98.384 to yield 6.88% or 210 basis points more than U.S. Treasuries. The deal was increased from $1 billion.

"That has been a horrible underperforming bond," said the buy-side source.

"You have the added duration that nobody wanted to take today [Friday] because they are in the risk-reducing mode."

Thursday's selling was mostly dealer-driven, commented the source.

"Yesterday [Thursday], a lot of people were selling a lot of long end in Mexico in general."

Oil spike hurts

Oil prices neared $49 a barrel Friday as oil production from the Gulf of Mexico was disrupted in the wake of Hurricane Ivan.

"Today [Friday] has been a slow day. Not a lot of flow. But markets are once again nervous about the political situation and the price of oil," said the strategist.

The Bush administration on Thursday said it would tap reserves of crude oil from the country's emergency stockpile.

"Unfortunately, prices have not changed their path and prices keep on moving higher," the strategist commented.

"That is a negative not only for U.S. markets, but also for emerging markets," he added.

While oil producers such as Mexico, Ecuador and Venezuela have gained from the spike in prices because of improvements to their current account balances, the overall increase in prices is not a positive for any economy, he said.

"The consumers in some of these countries like Chile and Peru, which are not producers, will tend to suffer a bit and to a certain extent so will Brazil."

Brazil's budget surplus

Meanwhile, Banc of America Securities made bullish comments on Brazil after the country indicated it plans to retire public debt, the first time it has talked about cutting debt since president Luiz Inacio Lula da Silva took office two years ago.

The comments came as Brazil announced an increase in its primary surplus target to 4½% of GDP from 4¼% for 2004.

"We believe that the renewed commitment of the Brazilian government to a first-rate fiscal policy will result in further improvement of its international financial standing and an increase in the price of its outstanding debt," wrote analyst Manuel Suarez-Mier in Friday's Banc of America Securities daily report, Situation Room.

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