Emerging market debt up on Fed rate hike; abundant liquidity driving market

By Reshmi Basu and Paul A. Harris

New York, Aug. 9 - Emerging market debt prices moved higher Tuesday as U.S. Treasuries rebounded in response to a neutral Federal Reserve statement.

The Federal Open Market Committee raised the federal funds target rate by an expected quarter percentage point to 3½%.

The Fed left its post-meeting statement largely unchanged from June's statement, hinting that a pause in the current tightening campaign is unlikely.

"The statement came a little bit more dovish than expected by some people in the market," said Alberto Bernal, head of Latin America research for think tank IDEAglobal.

Some were betting that the Fed's statement would be increasingly hawkish, he said. Since that did not happen, the yield on the 10-year note fell below 4.40% after making a charge at 4.44% earlier in the session.

"People are realizing profits here because they have been short for quite a while and they are probably closing out their positions.

"We might not see the 4.50% level in the current widening run," Bernal added.

The yield on the 10-year note stood at 4.40% from 4.43% on Monday.

That Treasuries bounce helped lift emerging market debt, said sources.

By the close of the session, the Brazil bond due 2040 was up 1.05 points to 118.55 bid. The Mexico bond due 2009 was bid at 1171/4, up half a point. The Philippines bond due 2025 added a quarter of a point to 110¼ bid.

EM resilience

Overall, the resilience of emerging market debt in the face of widening Treasuries is quite impressive, according to Bernal.

"EM has been able to survive the 40 basis points widening of the U.S. Treasuries market showing very stable behavior," he remarked.

"And that basically tells me that the market still remains quite comfortable with the idea that perhaps we will definitely see a fully flat U.S. yield curve."

Bernal added that a flat yield curve provides a structural backdrop in which sovereign debt can continue to perform well.

He noted that ample liquidity conditions are proving the market with its strength.

Negative headlines tend to be brushed to the side as the search for yield becomes a dominant force.

"Liquidity is key," said Bernal.

"Liquidity has allowed countries like Ecuador to trade around 700 basis points, despite all of these problems on the finance ministry and the lack of understanding of where they are heading with economic policy."

Last week finance minister Rafael Correa resigned, sending bond prices down. Deputy finance minister Magdalena Barreiro was sworn as his replacement after Monday's session. Ecuador performed better Tuesday after the bond due 2030 bond lost nearly 2 ½ points on Monday.

During the session, the Ecuador bond due 2030 gained a quarter of a point to 87½ bid.

"If we did not have liquidity, we should have seen much more pronounced movements on those specific bonds and on those specific complicated credits. But when liquidity is there, you can pretty much sell everything," replied Bernal.

A sellside source said he has mixed feelings as to the strength of emerging markets, given that the search for yield has boosted the market.

"People out there are looking for yields," he said.

"People have been expecting for Treasuries to be higher for the last year.

"From a yield point of view, EM has made sense," said the sellside source.

"More people are playing emerging market than before," he added.

While liquidity continues to be the driving force behind this rally, IDEAglobal's Bernal added that the fundamental story for Latin American countries such as Argentina, Brazil, Colombia, and Mexico have improved recently on the macroeconomic side.

But Bernal said he continues to be a little bit concerned from a valuation point of view.

Bernal advises that investors must be vigilant as spreads on the JP Morgan EMBI Index are at 280 basis points more than Treasuries.

"The issue, however, is that it does not make sense to short the market at these levels without having any expectation of unprecedented or derogatory external shock affecting the market.

"We saw the China re-evaluation having absolutely no effect. That was a possible source of volatility," he told Prospect News.

Oil prices are one of the most important variables in the long-run scenario, added Bernal, who added that the consumer price index in the United States has shown resilience as the price of oil hits record-highs.

"For the time being, I fully recognize that this is a gray 'easy' recommendation, but there isn't another one to place. Valuations are tight. But at the same time it doesn't make any sense whatsoever to get out, because there is no where else to go."

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.