Emerging market debt lower on Treasury spike

By Reshmi Basu and Paul A. Harris

New York, April 13 - Emerging market debt moved lower Thursday as the yield on the 10-year Treasury note spiked above 5% for the first time since June 2002.

Strong retail sales and consumer-sentiment data in the United States reinforced speculation that the Federal Reserve would continue to increase rates beyond its May meeting. At that meeting, the central bank is expected to hike the fed funds rate by 25 basis points to 5%.

Sources noted that the U.S. Treasury curve was steeper as the long end came under more pressure. The yield on the two-year note was spotted wider by four basis points to 4.93% while the yield on the 10-year note blew out by six basis points to 5.03%. The yield on the 30-year bond was seen at 5.22% from Wednesday's close of 5.16%.

Earlier in the week, emerging market investors had begun to unload risk ahead of the holiday weekend. And that trend continued into Thursday, observed a trader.

As Treasuries sold off, emerging market debt ratcheted losses on a dollar basis, mostly on the long-end of the curve, noted a market source.

In late afternoon trading, the Brazilian bond due 2040 was down 0.35 to 126.80 bid, 127 offered while the bond due 2037 was off by 0.65 to 94.50 bid, 95 offered. The Colombian bond due 2012 was seen unchanged at 116.25 bid, 117.25 offered while the bond due 2033 was spotted at 134.50 bid, 135.50 offered, down 0.30. The Russian bond due 2030 was seen at 107.875 bid, 108 offered, down 0.50.

But despite the Treasuries weakness, spreads for the asset class were virtually flat for the week.

Lebanon calls off exchange

In other developments, the Lebanese government has decided to cancel its debt exchange offer, following a court ruling, which favors former mobile operator LibanCell for $270 million. LibanCell had asked the court to freeze assets of the Lebanese government because of its failure to pay the company for prematurely canceling contracts in 2002.

The court has ruled to suspend the cash operations of the Lebanese government.

The cancellation is an embarrassment to the government, noted a market source.

Additionally, the exchange was critical because $3 billion in eurobonds are set to mature this year.

The source also pointed out that $270 million compared to $3 billion is peanuts, wondering why the government chose to suspend the exchange instead of settling with LibanCell.

Unwinding carry trade

In an environment of rising short-term rates and with emerging market spreads at or near their all-time lows, the carry trade will be become more difficult to achieve than it has been in the last year, according to Carl Ross, head of emerging markets research at Bear Stearns & Co.

As the carry trade unwinds, Ross noted that some countries will enjoy more of a cushion, mentioning Brazil and to a lesser degree Turkey. He also named single-B credits such a Jamaica among the few fortunate credits.

"There aren't that many," he said.

"Most of the double-Bs are trading below 150 over on the 10-year. And it's pretty rare to find anything that is giving you a spread of 200 over on the 10-year."

Ross added that given how flat the yield curve in the U.S. Treasury market is, there is very little difference between borrowing short term and long term.

"You still have some carry in this market. But clearly the cushion is low and has been low for most of the year now."

Nonetheless, Ross pointed out that the carry trade story does not dominate the asset class.

There is now enough money dedicated to emerging markets which is not necessarily based on the pure carry trade to provide some stability. In addition the market is being seen as a more serious fixed-income asset class in its own right.

"There's not much of a carry trade in investment-grade debt either. I think for some investors, who are carry trade-oriented, it's becoming more difficult.

"But I think the vast majority of the market out there views it as an asset class that they should still be invested in.

"Is it going to be harder to make double digit returns in this market? Absolutely, we think that returns for this year could be in the 5% range on a total return basis, depending on your scenarios for spreads and U.S. Treasuries," he told Prospect News.

Furthermore, if investors are to stay one step ahead of the market, the search for yield will be replaced by a credit-picking strategy, suggested Ross.

"What we've seen in the last several months is a pretty significant convergence in yields and spreads across emerging markets," meaning that "the difference in yields between doubles-Bs and single-Bs and between double-Bs and triple-Bs has contracted," Ross said.

He observed that investors have not been distinguishing creditworthiness among the countries.

"So the question is, if we are entering a more volatile environment where Treasuries are going up and the market may be a little bit more vulnerable, will credit stories matter more?"

The answer is "yes," said Ross, adding that the investors who look to outperform the market will want to focus on avoiding the countries that are likely to widen.

"It's more of an accident-avoidance kind of market rather than trying to pick the countries that are going to rally significantly because I don't think any country is going to rally significantly in this market.

"I think some countries will be vulnerable to significant down-trades and those are the ones to avoid," Ross concluded.

© 2015 Prospect News.
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