Emerging markets rally; low flows, light liquidity remain; investors expect bailout deal this week

By Aaron Hochman-Zimmerman

New York, Sept. 30 - Emerging markets were dragged back up by equities as prices benefited from a mild recovery on Tuesday.

Still, flows were light with many desks undermanned due to Rosh Hashana, the Jewish New Year.

"It's not so bad," a London-based trader said about the market on Tuesday, although "in a nutshell it always felt like it was going to open lower because of the day before."

Despite some gains after Monday's massacre, the consensus was that the underlying problems remain.

"Liquidity is as bad as it ever was," the trader said. For emerging markets "nothing's better."

Investors were somewhat heartened by the prevailing belief that a deal in Washington, D.C., to provide some form of bailout would come on either Thursday or Friday.

"It's assumed it's a done deal sometime later on this week, in some form," the trader said.

Elsewhere, Argentina announced that it will begin working with banks to restructure $20 billion in defaulted debt, but even that development carried less weight than the major market events.

"It's been like that as long as we care to remember," the trader said about the heavy influence of the major markets on the emerging economies.

Meanwhile, in the major markets, equities roared back as investors scrambled for deals, sending volatility down past 40.00 by 7.33 to end at 39.39, according to the VIX index. The index is a common measure of market volatility.

Emerging Europe rebounds

"The market's wary of going lower," a trader said.

"Whatever happened yesterday with the vote, the market's convinced that it's going to get solved this week," he said on Tuesday about the U.S. government's bailout program.

In Russia, president Dmitry Medvedev called for the country's military to bolster its nuclear arsenal, according to the Itar-Tass News Agency.

"Alongside re-equipment of the army and the navy and measures to enhance their mobility, the strategic nuclear deterrence force should be strengthened, a unified system of air and space defense created, and the status of Russia as a great maritime power raised," he said in the report.

However, Russia also announced that it would like to partake in talks aimed at accession to the World Trade Organization so long as certain conditions are met.

"Additional pre-conditions set by certain partners at the negotiations bring to naught the benefits Russia could get from entering into the WTO," said Valery Loshchinin, a representative to the U.N.'s Geneva headquarters.

Loshchinin admitted that negotiations may move slowly until the new U.S. president is in place on Jan. 20.

The Russian sovereign bonds due 2030 improved 1 point to 101.5 bid, 102 offered.

In Turkey, the central bank said "a measured rate cut would be considered should the favorable outlook in inflation and commodity prices continue," according to a press release.

Inflation eased in August, the bank said, as "consumer prices fell by 0.24% in August, bringing inflation down to 11.77% year on year."

The bank also noted a slowdown in growth as the GDP grew by 1.9% in the second quarter, but fell 0.6% on a seasonally adjusted basis.

The lira was seen trading at 1.2672 to the dollar.

The Turkish government bonds due 2030 managed to add 0.5 point to 144.5 bid, 145 offered.

In South Africa, after the wave of government regulations which put Kgalema Motlanthe in the presidency, finance minister Trevor Manuel said it is unlikely the African National Congress will split.

The country's ruling and only major party has been consumed by the struggle between former president Thabo Mbeki and his chief rival Jacob Zuma.

Some had suggested that the fissure would lead to progress toward a multi-party democracy.

Asia recovers losses

"Things are basically turned around over the course of the day in Asia," a trader said.

"We really tested the wides" early in the day, he said, "then snapped back in pretty quickly, back to unchanged."

South Korea's five-year CDS exemplified the market's demeanor by stretching as wide as 50 bps during the day but ending flat at 185 bps bid, 177 bps offered.

Still, Asia felt less like an outperformer on Tuesday, the trader said.

The high-yield corporate issues underperformed Latin America, he said, and came close to matching emerging Europe's performance.

However, the CDS only tells a slice of the story.

"The CDS is actually overstating the case," he said.

"The underlying cash markets are actually pretty weak," he said. "The high-grade stuff is generally weak."

The currency market, in addition to the action in Washington, D.C., was felt strongly in Asian credit.

In Indonesia, the government reacted positively to the proposal by state-owned Bank Mandiri to buy the Netherland's Indover Bank from Bank Indonesia.

"I think it will be good for Mandiri, as opening branches in foreign countries is considered to be very difficult nowadays," said Said Didu, secretary to the state minister for state enterprises, according to the Jakarta Post.

Bank Indonesia, the central bank, is selling Indover in order to comply with a 2004 law that prohibits it from owning financial institutions which may present a conflict of interest.

The bank also plans to sell insurer PT Asuransi Kredit Indonesia and financial services group PT Bahana Pembinaan Usaha Indonesia.

The sale of Indover is expected to be completed by the end of 2009.

The Indonesian government bonds due 2017 were seen flat at 91 bid, 92 offered.

Also in Asia, India and France announced an agreement that will allow for the sale of nuclear technology and hardware to New Delhi.

"Today we are at the intergovernmental stage, and after that the industrialists will begin their cooperation," said a spokesman for French president Nicolas Sarkozy, according to the AFP.

India already uses nuclear power and maintains a stockpile of nuclear weapons.

Local market strength in Philippines

In the Philippines, the local loan market showed "strong growth in July," according to a central bank press release, as growth hit 23.9%, up from June's rate of 24.2%.

Bank governor Amando Tetango "noted that these developments indicate that liquidity in the financial system remains ample, providing the financial resources necessary for sustaining economic growth," the release said.

Meanwhile, domestic liquidity, measured by the depository corporations survey, grew by 4.1% in July, down from 5.1% in June, the bank said.

"The expansion in domestic liquidity continued to be driven by net foreign assets, which grew by 12.5% in July, albeit lower than the 17.7% growth posted in June," the bank said in a statement.

The peso was seen trading at 47.03 to the dollar.

The Philippine sovereign bonds due 2030 were also unchanged at 123.5 bid, 124.5 offered.

Argentina signs restructuring deal

In Argentina, cabinet chief Sergio Massa announced that the government reached a deal to negotiate a restructuring of $20 billion in defaulted debt.

Barclays, Citigroup and Deutsche Bank will enter into talks to attempt a debt swap more successful than the offer of less than 33 cents to the dollar attempted in 2005.

The swap will give investors the opportunity to change their defaulted bonds for the discount bonds due 2033.

The default in 2001 and 2002 left $95 billion in debt in the hands of investors.

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