Tone in emerging markets sullied by soaring oil prices; funds lose $12 million

By Reshmi Basu and Paul A. Harris

New York, Oct. 14 - Emerging market paper headed south for the second straight day on profit taking as oil prices hit record highs.

"High prices is good for oil producers such as Venezuela, Russia, Nigeria, bad for everyone else," said a debt strategist, who said that Caribbean nations, such as the Dominican Republic were particularly hurting.

But in trading Thursday, even oil producers felt the sting of soaring prices. The Venezuela bond due 2027 fell 1.40 to 100.65 bid. The Ecuador bond due 2030 lost 1¾ to 85½ bid. The Russia bond due 2030 was bid at 98.812, down 0.001.

"We had a difficult day in the market overall," said a Latin America debt strategist for Refco EM.

Paper from Brazil was softer during Thursday's session. The C bond was bid at 98.623, down a point while the bond due 2040 lost 1.7 to 112.10 bid. Overall, the JP Morgan EMBI+ Index was down 0.65%.

"The day started with the negative news on the trade balance on the U.S.," said the Refco strategist.

The U.S trade gap grew to an alarming $54 billion in August as spending on oil imports reached new levels and exports declined.

Furthermore, the market's mood soured as oil prices neared $55 a barrel on news of a drop in U.S. commercial inventories. Crude oil hit a record $54.88 a barrel before ending at a record high closing price of $54.76 dollars.

Stocks plunged, with the Dow Jones Industrial Average falling convincingly below 10,000 to end at 9,894. Contributing to the downdraft, the U.S. trade deficit was reported at $54 billion for August, the second highest level ever, and initial jobless claims rose 15,000.

Sentiment worsens

"The market is turning to a much higher negative sentiment, which is also affecting emerging markets. There wasn't really news that explained the performance of sovereign bonds today [Friday], except higher oil prices," said the strategist.

"But in the previous days, we had a combination like we had today [Thursday] with higher prices of Treasuries and higher oil prices would tend to benefit some of the countries in emerging markets. Today [Thursday] was not the case," he commented.

U.S. Treasuries were lifted by crude oil prices, higher weekly jobless claims and the widening trade deficit. The yield on the 10-year bond was 4.01%, down from 4.08% on Wednesday.

"Oil is hurting EM through U.S. equities and generally higher global risk aversion," said an emerging market analyst.

"High oil prices will help the heavy oil exporters outperform the rest of EM, and credits like Venezuela should be fine," he said.

But higher risk aversion could mean serious trouble for those credits with heavy external debt service requirements, like Brazil and Turkey.

"Higher oil prices also has people worrying about inflation in some EM countries, with Brazil again a focus of concern.

"I think as long as oil keeps pushing towards $60/bbl, and U.S. equities continue to trade lower on the back of higher oil prices, EM is going to continue to get hurt," he concluded.

But the first debt strategist noted that overall emerging markets are not having a knee jerk reaction to each and every oil spike as the sector did in the 1980s. The profound difference between now and then - widespread world inflation. Fundamentals are much stronger this time around.

"The correlation between Treasuries is opposite to what it was in 1981 and 1982," he said.

One question that does emerge is whether these high oil prices have triggered a market correction.

"The equity market has had a couple of corrections," said the Refco debt strategist.

"I think the emerging markets could have a correction - not to the level that we had back in the beginning of the year.

"But it seems the sentiment is going the other way, even with the absence of good or bad news in the [Latin America] region."

Funds see $12 million outflows

Emerging market bond funds had outflows of $12 million of cash in the week ending Oct. 13, according to EmergingPortfolio.com Fund Research. This is the second straight week outflows during which time these funds have lost a total of $204 million.

Inflows are $400 million for year-to-date, which is 2½% of their beginning of year total assets.

Global bond funds had inflows of $251 million in the week, making it the ninth week of inflows in the past 10 inflows. These funds have had $4.9 billion of inflows year to date.

Russia worries

In Russia, the Duma voted Wednesday to overturn a ban on political party leaders becoming ministers. The lower house of parliament passed the ban by 344-69 with support from all parties except the Communist party.

"I think that's making people nervous that they could be headed back to Soviet-style one-party rule," said a sellside source.

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