Emerging markets drops with U.S. equities; high-beta names lead drop; Turkey lower on budget worries

By Paul Deckelman and Aaron Hochman-Zimmerman

New York, Sept. 5 - Secondary trading in emerging markets bonds moved to the downside on Wednesday, investors taking their cue from the fall in U.S. equities - widely considered a proxy for more risky asset classes, a category which also includes global equities, high yield bonds and EM debt - which followed a pair of privately issued reports showing employment and home sales slowing. Paradoxically, there was more bad news, of sorts, from some ostensibly good news, as the Federal Reserve's Beige Book said that the recent credit crunch seemed confined only to certain segments of the economy - and since the overall economy was not yet deteriorating markedly, that seemed to indicate that the central bank might not go along with financial market wishes and cut interest rates later this month after all.

The Beige Book notwithstanding, with concern growing about a slowdown in the U.S. economy - the largest export market and main trading partner for many emerging countries - bonds of those countries were seen generally lower, with risky high-beta credits Venezuela, Argentina and Ecuador leading the way downward, naturally, but bonds of other not-so-risky names like Mexico and Brazil also seen lower.

Far Eastern bonds, such as those of the Philippines, were seen pretty much rangebound, while Turkey was easier on investor concerns about the country's burgeoning budget.

Stocks cascaded downward on the heels of the bad news from ADP Employer Services, which reported U.S. job growth of 38,000 positions in August, the fewest since June 2003 and less than half of what Wall Street was looking for; from the National Association of Realtors, which said the number of Americans who inked contracts to buy previously owned homes plunged in July by the most since the group began keeping records in 2001; and from the Fed, which said in its Beige Book, based on snapshots from the 12 regional Fed banks, that the economy was still expanding and the credit crunch mostly limited to housing - which could convince the central banks' governors to stand pat and not lower interest rates later this month as the markets would like.

Collectively, that pushed both the S&P 500 and the Nasdaq Composite Index down by around a percentage point, while the bellwether Dow Jones Industrial Average fell 143.39 points, or 1.1% percent, to 13,305.47. But U.S. Treasuries on the other hand were the beneficiaries of an investor flight-to-quality reaction to the bad news and the Fed's bad good news, with 10-year note yields falling 8 basis points to 4.47%, their lowest level in six months, while two-year note yields fell by 12 bps to 4.02 percent.

Combined with the lower prices and higher yields seen for many emerging market names in Wednesday's dealings, the average spreads of EM bonds versus Treasuries, considered the key gauge of investor aversion to risk, or embrace of it, widened out markedly. The EMBI+ index compiled by JP Morgan & Co. widened 9 bps on the session to 232 bps.

High-betas key downsiders

As is usually the case when EM bonds are notably in retreat, the volatile bonds of high-beta names Venezuela, Argentina and Ecuador were right in the thick of things on Wednesday.

Venezuela's benchmark 9¼% dollar-denominated global bonds due 2027 dropped nearly 1¾ points to finish at around the 98.5 level, while its yield ballooned out by 20 bps to 9.40%.

A little less further out along the yield curve, its 5¾% global bonds due 2016 dipped about ½ point to 81.70, their yield widening 10 bps on the day to 9.04%.

Argentina's inflation-linked Discount bond in pesos fell to ARS109.75 from ARS111.9 Tuesday, with its yield widening to 8.67%, while the Par bond in pesos fell to ARS40.50 from ARS40.70, while its yield pushed up to 7.73%.

Besides the tendency of Argentine bonds to be among the leaders in any EM fall, observers noted that investors were concerned about inflation figures due out on Thursday afternoon; while a moderate reading is expected, somewhere around a 0.6% rise in August's consumer prices, market players have been skeptical for months about the truthfulness of government-generated inflation statistics, feeling they are being lowballed by the administration of president Nestor Kirchner for political purposes - Kirchner's wife, Cristina, is the front-running candidate to succeed him in the upcoming elections. Buenos Aires continues to deny that the books are being cooked.

Ecuador's benchmark 10% notes due 2030 were quoted down ¾ point at 86.75.

Brazil, Mexico easier

Apart from the risky high betas, Brazil's benchmark 11% global bonds due 2040, considered the most widely traded and liquid EM bond, were down 3/16 point to finish at an even 132. Its real-denominated zero-coupon bonds due 2008 were steady, its yield hanging in around 11.20%.

Mexico's benchmark 10-year bonds were also easier, their yield rising to 7.83%, about a 10 bps widening out.

Asian bonds firmer on Tuesday data

Apart from Latin American trading, Asian bonds were seen better earlier Wednesday - the third such consecutive session - as participants reacted to the way U.S. stocks had pretty much shrugged off Tuesday's data showing manufacturing had slowed in August versus July levels, data which came in pretty much as analysts had expected. With no real downside surprises, stocks had risen across the board during the U.S. trading day Tuesday - Asia's overnight period - creating some momentum for the Far East to ride upon.

Philippine government benchmark bonds due 2031 were quoted at 107.125, up nearly ½ point, while its 2032 bonds were seen at 96.5, up around the same amount. The cost of hedging against a default via credit default swaps contracts narrowed 6 bps to the 174 bps level - a sign of increased investor confidence in the safety of the bonds.

In the corporate sphere, MagnaChip Semiconductor Ltd.'s 8% notes due 2014 "firmed and tightened" to 61.5 bid, 63.5 offered from Tuesday's 60 bid, 65 offered, a trader said, although he saw no fresh positive news out on the South Korean computer chip manufacturer.

The trader said the company's other issues stayed pretty much the same, with its 6 7/8% notes due 2011 at 78 bid, 80 offered and its floating-rate notes due 2011 at 82 bid, 84 offered.

Turkey bonds ease on budget worries

Turkey's bonds, as well as its lira currency, were seen easier, partly in response to the generalized weakness in global markets, and partly on investor concerns in that country about the expanding government budget.

The benchmark 2009 issue retreated marginally as its yield rose to 18.15% from Tuesday's 18.12%, although those yields remain well below their recent highs at 18.46%, seen last week in the wake of Parliament's controversial selection of devout Muslim Abdulah Gul as president - a move which could worsen the growing divide between the country's traditionally secularist establishment and its increasingly assertive Islamist faction.

With Gul having uneventfully assumed his largely ceremonial, but symbolic office, investor concern is seen turning to worries that Ankara has not been exercising tight enough budgetary discipline, especially in the run-up to July's legislative elections, which were handily won by the ruling AK Party. The investors are looking to newly re-elected prime minister Recep Tayyip Erdogan, who was given a parliamentary vote of confidence Wednesday, to unveil measures to bring spending and revenues more closely in line.

How much of a daunting task this might be was emphasized Wednesday, when the government's State Planning Organization warned that flagging tax revenue levels could pose a risk to meeting budgetary targets.

South Africa bonds hang in as oil, rand sideline players

South African bonds were steady in range-bound trading, with activity restrained by investor wariness in the face of higher oil prices, a weaker South African rand currency and poor data reported last week. Some shorts were seen squaring their positions.

The key government R153 bond due 2010 closed at a yield of 9.36%, unchanged on the day, while the short-term R196 was bid at a yield of 9.62%, also unchanged. The longer-term R157 bond due 2015 was yielding 8.665%, up marginally from 8.660% before.

Observers said that movements in the rand, and the U.S. and European markets were seen likely to provide future direction to the bond market - the latter especially in terms of investor reaction to interest rate decisions which are expected Thursday from the European Central Bank and Bank of England.

Primary waits for leader

In the primary market, issuers continued to keep their chips far from the table as they watched to see who would take the lead and make the first post-U.S. Labor Day offering.

Uncertainty still looms over the extent of the U.S. subprime crisis and the potential for a rate cut by the Federal Reserve Bank, but spirits remain high as the market inches further into the fall season, which historically has shown a rebound after a slow-paced summer.

Along with the high spirits, volatility is up as well and is still a factor playing on investor's minds. The VIX index closed up 1.83 points finishing at 24.61.

Despite the continued lack of new issues and fluctuating volatility, emerging market fundamentals have remained strong enough to keep investors from budging from their optimism.

"It's feeling a lot better than before the weekend," a buyside source said.

Meanwhile, emerging markets have held their strength when compared to the high yield market, in large part because of their diversification which is one of the major advantages of the emerging market sector, according to an emerging markets strategist.

"Historically there's a better spread in EM," the strategist said comparing emerging markets to high yield.

"That had diminished, although it's come back," the strategist added about emerging market spreads.

Argentina rising

Corporations and especially banks in Argentina are showing growth potential as they improve their balance sheets, according to a market source.

The risks which are generated by the global financial situation as well as domestic uncertainty are expected, but are not overly discouraging either, the source said.

The source expects GDP growth from Argentina at the rate of 8% in 2007 and 6% in 2008 as domestic demand and commodity prices are both relatively high.

Economically Argentina's growth expects to level out to a "more sustainable level," the source said, which will hopefully stem fears of runaway inflation.

However, a global slowdown may derail growth leaving less of a demand for Argentine financial assets, the source said.

The fiscal policies that the government currently has in place should "continue to boost consumption," the source said despite continuing market volatility.

An opportunity exists for "substantial growth" in the banking sector, if the banks are able to find a way to lengthen the terms of the deposits they hold, the source added.

Investors may benefit from larger growth potential in Argentine banks than they might in banks elsewhere in Latin America, the source said.

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