EM sees firmer tone; Peru up on banks' upgrades

By Reshmi Basu and Paul A. Harris

New York, April 11 - Emerging market debt traded with a firmer tone while Peruvian bonds moved higher Tuesday on news that both JP Morgan and Merrill Lynch had upped their weightings of the country in their model portfolios.

Sources called it a surprising move, given the uncertainty surrounding the presidential election.

On both Monday and the earlier part of Tuesday's session, Peruvian spreads were chasing election results.

Trading for the sovereign bonds whipsawed throughout the session. At the opening, the bonds were down but later in the day the bonds were given a boost by the upgrades. JP Morgan moved Peru to overweight from neutral and Merrill Lynch moved the sovereign's debt to neutral from underweight.

On Tuesday, nationalist Ollanta Humala garnered 30.84% of the ballots tallied. Former president Alan Garcia was in second with 24.62%, while market-favorite Lourdes Flores nabbed 23.71%.

Humala fell short of expectations based on pre-election polls and both JP Morgan and Merrill Lynch suggested the "hidden vote" of overseas Peruvian nationals would push Flores ahead of Garcia - leaving Flores and Humala in the run off.

But in the razor-thin race for second place, one trader said that it was too statistically close to make such bets. Additionally, he added that there were too many unanswered questions surrounding Garcia's ability to preside as president.

"There are too many unknowns," said Enrique Alvarez, Latin America debt strategist for IDEAglobal.

"Will there be a chance to buy Peru on a bounce? I definitely think so, but I still think that you have to position for uncertainty," he added.

"I think they [JP Morgan and Merrill] are a little bit ahead of the game."

One buyside source said he was staying out of Peru until the story settles down, and that maybe even after May's run-off election.

But Alvarez noted that at some point, investors would want to pick up the paper on the negative news.

"The problem here is that uncertainty is still on the table. You have a lot of the locals betting in a positive direction, which means if that there is a surprise in the final tally, and it's actually Alan Garcia versus Humala, you are going to get locals pressuring the market like crazy both on the currency side, probably on the equities side, probably on the debt-side," he noted.

And in light of that prospect, any brave soul who is still invested in Peru will be in trouble, he remarked.

EM firmer

Overall, emerging market debt traded with a firmer tone. During the session, the Brazilian bond due 2040 increased 0.20 to 127.10 bid, 127.20 offered. The Russian bond due 2030 gained 0.38 to 108.25 bid, 108.625 offered.

Besides Peru, other underperformers included Venezuela, which may have suffered from Merrill Lynch's decision to cut its exposure to market weight.

"I think people are pretty much convinced that Venezuela is over-extended here - that valuations have turned rich," observed Alvarez.

Ecuador still churning higher

Meanwhile Merrill Lynch moved Ecuador to overweight from market weight, citing the muted political reaction to its plan to exercise a $740 million call option on the country's bond due 2012.

Alvarez is also puzzled by the bank's decision, given that the redemption does not solve any real problems. While there are some savings, the market has already priced Ecuador's buy back scheme.

Furthermore, the country faces some real challenges on the local front.

Merrill Lynch lauded Ecuador's passage of a new hydrocarbons law that will result in the yearly addition of approximately $600 million to the public sector's coffers.

The law pushes for foreign companies to give up a larger slice of revenues.

But Alvarez warns that it will only add value to the economy if everyone accepts the terms of the modified hydrocarbons law.

"It's very similar to what went on in Venezuela - not a total expropriation. This has to do with the amount of profit-taking at a certain level of oil prices.

"However, it can be viewed as an appropriation of some of the profits that were promised to these companies in a very unilateral fashion," he commented.

Nonetheless, Alvarez is puzzled as to why the passage of the law has been hyped so much, given that it sends a negative message to foreign investors over the medium term.

During the session, the Ecuadorian bond due 2030 added 0.25 to 99½ bid, 100 offered.

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