Emerging markets up on Fed-inspired equities rally; Argentina jumps, South Africa shrugs off rate worries

By Paul Deckelman and Aaron Hochman-Zimmerman

New York, Aug. 7 - Emerging market bonds continued to push upwards on Tuesday, spurred on by gains in the U.S. equity market, taken as a sign that investors are ready to assume more risk in their holdings.

Argentina was the major upside mover, although most Latin American names were up. Earlier in Asia, Philippines and Indonesian CDS contracts came down in price. South Africa's bonds firmed despite the likelihood of a hike in interest rates.

After some initial weakness, stocks moved upwards after the Federal Reserve Board - as expected - left the key U.S. overnight lending rate in place at 5.25%, said it expects the American economy to keep growing, and meanwhile promised to maintain its vigilant stance against a renewal of inflation.

That pushed the S&P 500 index up 9.04 (0.6%) to 1476.71, while the Dow Jones Industrial Average rose 35.52 (0.3%) to 13,504.3. Meanwhile, yields on the benchmark 10-year Treasury note rose almost 5 basis points from Monday's closing levels to 4.78%.

The rising Treasury yields, plus the gains notched by emerging debt, combined to tighten the average spread between emerging yields and comparable Treasuries by 9 bps to 207 bps, as measured by the widely followed JP Morgan & Co. EMBI+ Index. The index serves as a key barometer of investor tolerance or aversion to risk.

There was no primary activity, although hope remains that activity will restart once the current bumpiness subsides.

EM market okay with Fed's pronouncements

Emerging bonds were already up well before the official release of the Fed's decision to leave rates unchanged and its other pronouncements on the economy at 2:30 p.m. ET. "The EM reaction sort of built up before the actual Fed communiqué," said Enrique Alvarez, the head Latin American debt strategist for IDEAglobal, an international financial research company.

"It had been a sort of recovery reaction, and I think this was sustained and improved, once the Fed was out of the way."

He said that "people are a little bit soothed by the fact that the Fed made some admissions as to the risks of the economy, but did not panic anyone by actually enacting any sort of rate cut or by making larger, heavier noise regarding the actual implications of the maladies affecting the U.S. subprime market and the corporate credit markets."

The strategist opined that "Latin America - at least the investors - seemed to have gained the conclusion over the last couple of days that no matter what the potential effects on the U.S. economy," the largest trading partner for many EM countries, "from the credit markets, Latin America seems to be somewhat isolated from whatever that fallout is. Therefore, they're starting to wade back into the high-beta type credits and picking up a little more exposure."

Argentina leads the way

Argentina, the highest beta of the volatile high-beta names, was the big winner on the day, Alvarez said, "a very, very large outperformer for LatAm, it was up about 4%. You had people coming back in, and taking some positioning and perhaps covering some shorts also there. So I think that was the most important event of the day among the LatAm names."

A market source indicated that Argentina's benchmark 8.28% dollar-denominated global bonds due 2033 were up a hefty 2¾ points on the session to 84.85, on top of Monday's ½ point gain.

Besides the global paper, Argentina's local-market bonds, after some early weakness sparked by unease over the latest batch of consumer price numbers coming out of Buenos Aires, managed to overcome those concerns and edged up about 0.5%, with some bonds doing even better than that; the dollar-denominated benchmark Par bond shot up 5% on the day.

The worries about the accuracy of the official government statistics impacted on the country's inflation-linked bonds, which comprise more than half of its paper. In the early going Tuesday, the prices of securities such as its 5.83% inflation-linked bonds due 2033 tumbled, and their yields, conversely, pushed up to the highest level ever since the bonds were issued in the fall of 2005 - 7.85%, as investors fretted about the 0.5% rise in July consumer prices reported on Monday. That figure came in below what most economists were expecting, leading skeptics to again assert that the official numbers have been manipulated for political purposes, an accusation which president Nestor Kirchner has repeatedly denied, but which continues to dog him.

Alvarez said that the ongoing controversy over the validity of those numbers is no small matter.

"It's very, very relevant," he asserted, "because one of the major sources of participation of investors in the local Argentine fixed-income markets have been the instruments that have been linked to inflation calculations."

Any problems with such notes, including and especially lack of confidence in the official statistics, means "there will be less liquidity in Argentine domestic markets, less foreign participation."

The controversy, he added, "will serve as a hindrance, a continuous hindrance, for Argentine bonds."

But not on Tuesday, where all other concerns were subsumed by "the relief-type short-covering rally."

Another factor help those bonds to come all the way back from their early lows, and then some, was the announcement from the government's recently installed economy minister, Miguel Peirano, that Argentina's primary budget surplus - i.e. the surplus before scheduled interest payments - was 3.4% of the gross domestic product. By the end of the session, the inflation-linked bonds had made up their earlier deficit and ended higher in price on the day, with the yield down to 7.75%.

Spurred by the relief rally, the cost of hedging Argentine debt by means of a credit default swap contract had fallen by 20 bps to 400 bps.

Venezuela, Mexico improved

In other Latin American debt action on Tuesday, Venezuela's bonds were up, although not quite as dramatically as Argentina's, with its dollar-denominated 9¼% paper due 2027 up more than ½ point to end quoted at 106.

Mexico's peso-denominated bonds got a boost from the Fed's assurances that the U.S. economy - Mexico's biggest trading partner - will continue to grow, albeit moderately and without too much inflation. The 10% notes due 2024 rose nearly ¼ point to just under 121.

While EM investors in general and the Latin component in particular were apparently heartened by the Fed's assessment, leading to the better market tone, Alvarez did caution: " I think you have to realize that for Latin America, there's still a risk here embedded in the U.S. corporate credit markets; the market is perhaps is turning a blind eye to that, but I think that at some point in time, it's going to have to return and focus on the particular issues at hand, such as the very large reassessment of risk that is present in U.S. corporate credit markets, throughout the ratings spectrum."

Asian bonds move upward

Elsewhere, emerging market debt had started earlier Tuesday with a rebound during the local trading day in Asia, encouraged by the Wall Street surge seen Monday during the North American trading day, which pushed EM bonds higher as well.

The price of a five-year CDS contract for Philippine sovereign debt was seen having come down to 190 bps, a pickup of about 4 bps, while the similar CDS contract on Indonesia's debt likewise was reduced by several basis points to about the 185 bps level. Both had shot as high as around the 250 bps area when market turmoil was at its worst at the end of July.

Among corporates, the spread between bellwether conglomerate Hutchison Whampoa's bonds due 2033 and comparable Treasuries narrowed about 5 bps to 188/184 bps.

The spread for big Indian issuer ICICI Bank's bonds came in as much as 20 bps to a wide 390/320 bps.

South Africa bonds better on robust rand

South Africa's bonds were seen better, even as the head of that country's central bank continued to send signals - the latest during a speech Tuesday - that an interest rate hike is probably in the cards when the bank's governors meet next week.

Despite that potentially bearish news from central bank chief Tito Mboweni, the yield on the bonds fell, helped by strength in the country's currency unit, the rand, and a well bid for auction of 500 million rand of new R209 bonds, as well as a generally better tone in the emerging markets as a whole.

Pretoria's bonds ended the day slightly off their highs, but well up from Monday's closing levels, with the yield on the benchmark R153 bonds due 2010 closing at 9.30%, down from 9.36% on Monday.

The yield on the short-term R196 bonds declined to 9.575% from 9.625% previously, while the yield on the longer-term R157 bonds came down to 8.58% from Monday's finish at 8.66%.

Primary quiet but hopeful

In the primary market long-term optimism hung on, but volatility still left the liquid cash frozen solid.

"It's been up and down," another syndicate official said, but added emerging markets are looking better than in days past.

The official said that the market had come down so much that there was a large amount of paper that was difficult to move, but now "there's a bit of a flow, it's a healthier market."

The official added the volatility is not over but will begin to fade.

"As we move into the second half of August, volatility will be less and less," he said.

Emerging markets has suffered, but over the length of the present downturn, managed to hold their value.

"EM held well, obviously they widened, but not as much as high yield, which is just getting slaughtered right now," the official added.

On the whole, the market is "definitely stronger today," said another syndicate official pointing to a good close for U.S. equities on Monday.

Fundamentals remain strong and liquidity is still very high, yet emerging markets are not completely out of the woods, according to an emerging markets strategist.

"I still expect further downside," the strategist said about the next two months.

The strategist expects the additional downturn affect corporates more than sovereigns.

Many emerging market countries have taken the opportunity over the last five years to dramatically improve their creditworthiness, the strategist said.

Generally corporates are in a weaker position, which may drive up risk and "create buying opportunities," the strategist added.

Despite corporate weakness, "I don't see a reason for EM to face a crisis ... We're optimistic money will be put back to work," the strategist said.

When emerging markets begin to recover, most likely in September, the rebound will happen very quickly, a market source said.

There is "extraordinarily high" liquidity in the market, the source said, but investors will be hesitant to commit until they are more comfortable gauging the direction of the credit market.

Gazprom hangs on

The prevailing stagnancy in emerging markets left Russia's OAO Gazprom looking to price at the end of the week.

Confidence is high in the Gazprom camp, but many others have their doubts.

"Gazprom isn't looking likely," said an emerging markets syndicate desk official who specializes in Europe and the Middle East.

"I can only imagine that the longer they leave it the less likely it will price," the syndicate official said.

"I don't think we'll get any new issues for the week," another syndicate official said.

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