Emerging markets better but spreads surrender most of session's gains; Venezuela, Ecuador strong

By Paul Deckelman and Aaron Hochman-Zimmerman

New York, Aug. 13 - Emerging market bonds did better Monday, continuing the momentum seen late in the session on Friday after the Federal Reserve and other major central banks stepped in to steady panicky financial markets by massive injections of liquidity.

On Monday, the Fed and the other banks cut the amounts they injected from the usually high levels seen on Thursday and Friday, which was taken by the markets as a good sign - a signal that things were starting to turn back to normal.

The primary market continued to drive in circles, unsure of how to find its way back to a healthy new issue pipeline.

"It's grinding up and down with no clear direction," a buyside source said.

Venezuelan and Ecuadorian bonds led the way in Latin American trading, with both of their dollar-denominated global benchmark issues seen up more than a point.

In Asia, credit default swaps made up the bulk of the action, with Philippine CDS contracts moving away from the tight levels they held earlier in the session, but ending essentially little changed on the day.

ICICI Bank bonds remained well below their week-earlier levels, despite the company's efforts to distance itself from the subprime mortgage lending problem.

Turkish investors were expected to grapple Tuesday with the news that a controversial presidential candidate thought to be an Islamist will run for that office under the banner of the most influential parliamentary party - threatening to revive a constitutional crisis seen earlier in the year.

Spreads give up most early gains

While EM bonds gained on the day, the key measure of emerging performance - spreads between the average yield on EM bonds and yields on U.S. Treasury paper - pared its gain, as Wall Street's early rally faded amid renewed subprime-related concerns, pushing U.S. Treasuries up from their early lows. The yield on the bellwether 10-year bonds fell 3 basis points on the day to 4.77%

Lower Treasury yields meantime led EM to give back much of its spread-tightening gains that had initially been seen. The average spread, as measured by the widely followed EMBI+ index compiled by JP Morgan & Co., tightened by 2 bps on the day to end at 205 bps - this after having tightened as much as 8 to 10 bps in the early going.

Asian market seen quieter

A New York-based trader in Asian debt said that with the uproar of last week's market gyrations now history, "it's a lot quieter in our markets today," adding that "for the first time, it's actually felt like a summer Monday."

He said that while EM was "still choppy, just given that the broader markets are quite choppy, we opened with a pretty good tone this morning, and followed equities higher and tighter." However, he said that "as equities have come off and as other credit markets have faded this afternoon, we have drifted a bit lower." But in the grand scheme of things, there was "not very much in the way of movement."

He said that the five-year CDS contracts linked to Philippine sovereign debt opened in a price range of 175/180 bps, got as low as 170 bps, but then moved back up to around 177/182 bps, "about 5 [bps] or so off the tights, but pretty much unchanged from where Asia left us" at the end of the local trading day there.

While the basis-point price of the Philippine CDS contracts - which moves inversely to the level of market confidence in the underlying bonds, one of the most widely traded EM instruments - had shrank into the 90s in early June, before the recent market turmoil began, that price had blown all the way out to around the 250 bps area in late July, at the depth of the market sell off.

"Other than that, there's been very little going on," he said, especially in cash bonds, as opposed to CDS contracts on the Philippine sovereigns and various other Asian debt instruments. "There's pockets of inquiry, but not a great deal going on. Spreads are generally unchanged."

During the Asian trading day, Philippine CDS contracts were quoted at a wide 172/185 bps, the price having fallen from the 180 bps seen on Friday.

The underlying Philippine cash bonds were seen up about ¼ point, its benchmark 2031 issue at 108.375 bid, 108.875 offered, and its 2032 bonds quoted at 96 bid, 96.50 offered.

ICICI statement hasn't much impact

Apart from the Philippines, ICICI Bank's 6.38% bonds due 2022 were quoted at 87.14, down slightly from Friday's trading level at 87.34, and well down from the 95.78 level at which the bonds had been seen closing just a week earlier.

The bid spread had widened out in that intervening week to 353 bps from 230 previously, the bonds' performance apparently not much helped by last week's declaration by bank officials that India's largest lender by market value holds no securities linked to the subprime mortgage meltdown in the United States, with virtually all of the roughly $1.5 billion equivalent of collateralized debt obligations on its balance sheet in India-linked paper.

"We have no exposure to the subprime market," one bank official flatly asserted.

ICICI's statement may have helped its bonds "a little bit," the trader said, but he added: "Indian bank paper has been one of the worst-performing sectors in this whole downtrend, mainly because there was so much supply from the sector" - both ICICI and State Bank of India brought big new deals to market earlier this year - "so the technical position is poor, with a lot of paper out there. So those spreads have come under quite a lot of pressure."

He added that "what we're seeing in Asia with a lot of the banks is the banks are being punished, to some extent for any perceived mortgage-related subprime-type exposures. So most of the institutions are either coming clean or trying to make it clear that they don't have any exposure [like ICICI], just to remove that air of uncertainty that's out there."

Trouble looms for Turkey

There was no word on any movement in Turkish paper on Monday. However Tuesday's trading could be impacted by the late-breaking news that the ruling AK Party has decided to go ahead and nominate the country's foreign minister, Abdullah Gul, for president - a move which could spark renewed controversy between Islamists within the AKP who favor Gul, and the secular sectors of Turkey's society, notably the military, who believe that Gul has a sectarian, Islamic agenda which they oppose.

An effort by the party to nominate Gul earlier this year threatened to spark a constitutional crisis - which sent the country's bonds, stock and lira currency reeling - until Gul's name was withdrawn.

Venezuela, Ecuador lead Latin America

In Latin American dealings, Venezuela's bonds were seen on the rise, with that country's benchmark 9¼% dollar-denominated bonds due 2027 quoted up 1½ points on the day to 104.5.

Fellow high-beta credit Ecuador's benchmark global 10% bonds due 2030 were quoted up 1¼ point at 87.25.

The Venezuelan, Ecuadorian and Argentine credits have been among the hardest hit in the recent market downturn, although they have also been leading the market upward on days when there was a snapback from the recent declines.

U.S. data may help

Emerging markets may be able to make up its mind as U.S. economic indicators including the producer price index, the consumer price index and the homebuilders' index, among others, are released Tuesday and Wednesday this week.

"The calendar will be much more interesting this week than last," the buysider said.

In addition to the economic data, the market may see the redemption of money from hedge funds within the next 15 to 30 days, the buysider said, adding that further headlines about hedge funds could move the emerging markets from its standstill.

A change in interest rates would also cause investors to take notice, however the Federal Reserve Board is unlikely to ease interest rates in the near-term, the buysider said.

"They need to see bodies floating before they do anything," the buysider added.

The liquidity added to the market by the world's central banks is helping, the buysider said, but is not enough to create real change.

"It doesn't seem like there's a lot of conviction for a rally," the buysider said.

Actions by the Fed and other banks may not have been a panacea for all market sectors, but "a liquidity crisis has been averted, thanks to central bank action, [however] the crisis of confidence in credit remains," an emerging markets strategist said.

"[Current] conditions will likely remain so until greater transparency is provided, related to underlying derivatives structures, their market values and holders," the strategist added.

Analyst suggests waiting out storm

An emerging markets analyst specializing in emerging Europe suggested investors wait out the stormy weather on the sidelines.

"It probably makes sense not to increase risk," the analyst said conceding that volatility has decreased in emerging markets across the board, but not enough to repair the broken new issue pipeline.

The analyst said investments in Mexican, Chilean and Russian sovereigns are relatively safer choices.

On the other hand, moving toward Venezuelan and Argentinean bonds or buying oversold issues are the riskier options.

The emerging markets strategist agreed that the current conditions do not favor playing investments for short-term or even medium-term gains.

The strategist cautioned against misinterpreting Monday's rally as anything other than the result of the liquidity injection from the central banks.

"We have been advising investors to take [Monday] morning's bounce as an opportunity to continue to reposition toward highly liquid names and high-grade credits ... The problem is no longer related to subprime and banks, and investors are beginning to raise questions about other credit derivative conduits, such as high-grade structured investment vehicles and other short-term commercial paper," the strategist said.

"Since investors are forward looking, they will have to start pricing this grimmer credit risk and liquidity risk outlook into securities fairly soon," the strategist added.

"I don't believe the downside we have seen yet reflects the impact of the recent crisis on future bank/investor willingness to provide credit and consequently upon medium-term issuer refunding risks," the strategist said.

Emerging markets are holding better than many other market sectors even as they are subject to "drag effects" from the higher yields in the core debt markets.

"Emerging markets are used to crises; other markets aren't used to crises," the buysider offered as a reason emerging markets has suffered less damage over the painful summer.

"There is a general recognition by investors that Goldilocks has stumbled ... It is worthy to bear in mind that in the original folktale, Goldilocks gets devoured in the end," the strategist said.

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