Emerging market debt continues slide on Treasuries pullback; Brazil's CVRD to issue 40-year notes

By Reshmi Basu and Paul A. Harris

New York, Oct. 13 - Emerging market debt remained in the doldrums Thursday, as investors continued to unwind their positions ahead of Friday's release of consumer price index in the United States.

In the primary market, Brazilian mining company Companhia Vale do Rio Doce (CVRD) said it plans to issue 40-year notes of unsecured unsubordinated debt via its wholly owned subsidiary Vale Overseas Ltd.

ABN Amro and HSBC are joint bookrunners for the sale.

During the session, the CVRD bond due 2034 was down 0.38 to 109½ bid, 110½ offered, a little more than the Brazilian sovereign lost.

Also Thursday, Chinese conglomerate Fosun International Ltd. postponed its downsized $325 million to $350 million offering of seven-year senior notes (Ba3/BB-) on Thursday.

The offering had been reduced from $500 million earlier in the week. The notes, which were being sold in a debt refinancing transaction, had been talked earlier in the week at the 9% area. Preliminary guidance had been 8½% to 9%.

Morgan Stanley and Citigroup were managing the deal.

U.S. Treasuries terrorize EM

Renewed inflation concerns have been reflected in a weaker U.S. Treasuries market, which saw its third straight session of price declines. The yield on the 10-year note made a stab at 4½% Thursday before settling at 4.47% compared with Wednesday's close of 4.45%.

As a result, emerging markets have seen selling pressure in both local and external markets.

For instance, Mexican local markets have been clobbered by a sell-off in both Treasuries and emerging markets, said a market source.

On Thursday, the peso declined 0.3% against the dollar. The day before, it closed down 1.1%.

On the external front, the Brazil bond due 2040 slipped a quarter of a point to 117.20 bid, 117.60 offered. The Mexico bond due 2026 lost two points to 156 bid, 157 offered. The Russia bond due 2030 slid one point to 110½ bid, 110.87 offered.

Ecuador bonds have also seen pressure coming off this week's resignation by interior minister Oswaldo Molestina, said a source, who added that the minister and president Alfredo Palacios did not agree on the direction of political reforms to be submitted to the congress. Molestina had been in the position just over a month.

The resignation speaks to the instability of the president's administration, said the source.

The Ecuador bond due 2030 lost 1½ points to 87½ bid, 88½ offered in trading Thursday.

Inflationary pressures

The main drivers behind the sell-off were very high valuations and renewed concerns over inflation in the United States, according to Alberto Bernal, associate director of fixed income research at Bear Stearns & Co.

"Prices have gone up very significantly in the past few months, so whenever you go higher, the correction tends to be stronger," he said.

"Inflation fears in the U.S. have sparked a rather material widening of U.S rates, with the 10-year safely trading north of 4.40%."

A couple of months ago, emerging markets appeared unstoppable, despite pullbacks in the Treasury market. Global liquidity and inflows into the market were credited for its resilience, as spreads grinded towards historic-lows.

"I think the clear difference between today and two weeks ago or a month ago is that external conditions are much weaker," said an emerging market analyst.

He added that the yields on the 10-year note are punching at 4.5% and are now higher than they have been since March.

"The VIX [CBOE Volatility Index] is higher than at any time since the GM/Ford downgrades back in April/May, and S&Ps are off 5% in a month.

"EM has been driven by external conditions for the last two years or so, and this latest pullback is no exception."

EM looks to CPI

Next, investors turn to Friday's release of the CPI data for more clarity into the U.S. inflation story.

And those numbers will determine Friday's performances, noted market sources.

Bernal added that there was even talk of the 10-year note stabbing 4.60% if Friday's CPI data turns out to be bearish.

And to protect themselves, investors have been shedding risk ahead of Friday's numbers, Bernal noted.

The market is expecting a gain of 0.9% for the headline CPI number, stemming from higher energy costs due to Hurricane Katrina and Hurricane Rita. Bear Stearns is expecting 0.3% for the core CPI number, higher than the market consensus of 0.2%.

"But my sense is that the market is preparing itself for a higher number," he observed.

Moreover, the last several sessions have given off the sense that the world is coming to an end for emerging markets.

"Being fair with the whole market behavior, we have moved from a level of 4% to 4.5%, so it is 50 basis points up in the U.S. yield curve. It is a material number. But nothing compared to the levels we saw five or six years ago," remarked Bernal.

He added that unless there is a very detrimental inflation picture, such as the possibility of stagflation fears, there is still time for the "search for yield" trade to remain intact.

"This is a dynamic market. That is a dynamic scenario. So prices will re-adjust to that new reality. But the backbone of the whole thing, which is high global liquidity, should remain in place as long as China continues to do well, as long as oil prices remain high, and the U.S. continues to grow at an acceptable but not booming rate."

Meanwhile if issuers were looking for an opportunistic moment to tap the capital markets, they may hold off, he said. But those countries that need financing will issue more paper.

However there are not many of those countries left since many Latin American countries are doing well on both the fiscal account and on the external front.

Therefore, supply could be very limited in the coming months, which is good for the asset class, remarked Bernal.

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