Emerging market debt tumbles on profit taking, oil spike; funds see outflows of $32 million

By Reshmi Basu and Paul A. Harris

New York, June 23 - Emerging market debt tumbled Thursday as investors cashed in on recent gains and high oil prices put pressure on the asset class.

Earlier in the session, emerging markets edged higher as the 10-year U.S Treasury stayed below the 4% barrier, but then later on risk aversion reared its head, igniting a pullback in sovereign prices.

Emerging markets was also hurt as the price of oil briefly hit $60 per barrel, according to Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal.

Even as yields on Treasuries remain below 4%, oil prices finally caught up to the market, Alvarez noted.

"Oil is finally beginning to make an impact on a risk basis. It's obviously been a big factor in the roll-down in equity prices in the U.S. today [Thursday]," he said.

As oil approaches $60 or beyond, markets such as U.S equities will transfer the lack of confidence into Latin America, Alvarez cited.

The Dow Jones Industrial Average snapped Thursday, posting its biggest drop in two months. The measure ended down 166.49 points to 10,421.44.

"High yield has been fairly quiet, pretty steady," said a buyside source.

"EM looks a little wider. Treasuries are down a little bit, but once again fairly quiet," he remarked.

"It's pretty easy on days when the equity market gets hit to have a market correction simply because of the rich prices in the market," he added.

The buyside noted that there was not a lot of margin for error in the asset class.

Brazil down on mess

Meanwhile, political uncertainty in Brazil dragged down the rest of Latin America, said sources. President Luiz Inacio Lula da Silva will deliver a speech Thursday night to address the ongoing political scandal, which has dogged his administration in recent weeks.

There are allegations that allies of the Workers' Party paid some lawmakers monthly allowances for support of government-backed legislation.

"The Brazil noise continues to expand," replied Alvarez.

"There's still uncertainty out there regarding what the ultimate direction will be after all of the facts are out," he said.

"Equities have been significantly weak in Brazil. The Bovespa has been off over 3%. All that is taking away strength and confidence away from the Brazilian bond side and transferring to Latin America," he cited.

During the session, profit-taking took a bite out of the debt market. The Brazil C bond lost 1/8 of a point to 101 7/8 bid while the bond due 2040 fell 0.80 to 118.70 bid. The Mexico bond due 2009 slipped 0.025 to 119.20 bid.

Despite high oil prices, oil producers also saw a price downturn. The Venezuela bond due 2027 fell 0.80 to 103¾ bid.

Alvarez said the pressure on Venezuela stemmed from the potential cap that is being considered on central bank reserves.

He added that he expects Venezuela to see some upside because of high oil prices over time.

But a buyside source commented: "I don't really see a pattern of oil [linked names] outperforming here."

"Russia seems to have had a good day, but Vene and Mexico are both down.

"There seems to be spread widening across the board: high-grade versus high-yield trade," he noted.

Ecuadorian bonds continued to sell-off off on proposed changes to the country's Fiscal Responsibility Law.

That news "has shaken people off," said the buyside source.

During trading, the Ecuador bond due 2012 dropped three-quarters of a point to 93¼ bid.

The buyside source added that he was surprised that Panama performed relatively well, given the recent setback to pension reform.

"They underperformed a little bit yesterday [Wednesday]. They are down a little bit today [Thursday] but are in line with the market," he noted.

Fund sees outflows of $32 million

Mutual funds lost investor cash this week. Emerging market bond funds had outflows of $32 million during the week ending June 22, according to EmergingPortfolio.com Fund Research.

These funds now have $3.327 billion of inflows year-to-date.

New issuers lower in secondary

Meanwhile in the primary market, Korea-based Hynix Semiconductor Inc. revised price talk on its restructured $750 million two-part offering of high-yield notes (B1/B+).

Talk on the restructured seven-year fixed-rate notes was raised to the 10½% area from the 9¾% area. The tenor of the notes was decreased to seven years from 10 years and call protection was decreased to four years from five years.

Meanwhile talk on the floating-rate notes was increased to six-month Libor plus 650 basis points from Libor plus 600 basis points area.

The books closed Thursday afternoon. Pricing is expected on Friday.

Citigroup, Deutsche Bank Securities, UBS Investment Bank and Merrill Lynch & Co. are joint bookrunners.

The proposed issue is putting pressure on Korean paper, according to the buyside source, who chose not to play given that it is a "fairly risky" company.

"The Hynix deal is pretty much a stand-alone deal," said a trader. "It's a decent-sized chunk of high-yield issuance to get done. Accounts will tend to look around and see who is getting involved," he added.

"There has now been a reasonable amount of supply out of Asia from a fairly varied number of issuers. And there is the Hynix deal ahead of us.

"The market is going to consolidate for a while given the backdrop and given the need to digest the supply.

"So the market definitely feels a little consolidative but nothing too dramatic."

In the secondary, new issues from Hong Kong-based conglomerate Hutchison Whampoa and IndoCoal were softer.

Hutchison priced a €1 billion issue of 4 1/8% 10-year notes (A3/A-/A-) at 99.75 to yield 4.156% on Wednesday. The deal was more than five times oversubscribed, said the trader.

The bond priced at a spread of mid-swaps plus 93 basis points, inside of the mid-swaps plus 95 basis points price talk.

"Because they said early on that the deal wasn't going to grow, and they were fairly straight up with the pricing, mid-swaps plus 95 basis points give or take a couple of basis points, it became the sort of thing that the market really likes at the moment," the trader noted.

"When people hear that a deal is not going to grow that will tend to exaggerate the size of the book.

"Exactly the same thing happened with Indosat. They said it wasn't going to grow.

"Hutch traded ok for most of the day but came off as credit generally softened, and there was some late-day selling in the Hutch-curve," he said.

ABN Amro, Deutsche Bank and HSBC were the bookrunners.

IndoCoal Exports (Cayman) Ltd., a subsidiary of Indonesian mining firm PT Bumi Resources Tbk, priced $600 million of seven-year senior secured notes (//BBB-) late Wednesday at par to yield a spread of 350 basis points more than Treasuries.

The deal priced at the wide end of price guidance. Guidance was set at Treasuries plus 325 to 350 basis points.

In the secondary, the new issue had a poor debut, trading below par, finishing at 99 5/8 bid.

A market source said the new bond is seen as Indonesian risk.

Merrill Lynch was the bookrunner for the offering.

Furthermore, the buyside source added that it doesn't seem that the new issues have outperformed.

"It seems more like it's high-grade versus high-yield trade going, with the riskier stuff underperforming. The Indocoal deal didn't go as well as expected.

"The market seems a little cautious here," he added.

Political noise to increase, warns buyside source

Looking ahead, political noise will only get louder, warned the buyside source, whether it comes from Brazil, Colombia, Ecuador or Peru.

"Colombia seems to be the one that is doing better lately, but I expect to see more noise like we saw in Brazil, which I think will unnerve the market and put some pressure on it," he told Prospect News.

The buyside source clarified that the recent scandal in Brazil is not a Lula scandal, but a story of "political games," as opponents gear up for an upcoming election.

"If you are not a part of the Workers' Party, you want to make him look as bad as possible, which improves your chances of winning,

"Lula is as clean as any other politician in Brazil - for what that's worth.

"No one is calling for Lula to resign. It is just mud raking."

Meanwhile, the political turmoil in Philippines is a more interesting story, according to the buyside source.

The Philippine congress has started a probe on allegations that President Gloria Arroyo tried to rig last year's election.

"It seems more like a smoking gun situation," he cited.

The buyside source has no exposure to the country's paper, given its high debt.

"Conventional wisdom is that they have to raise taxes and that will fix the problem.

"It seems to me that they either raise interest rates and that's good for rating agencies and that causes the country to lose growth or they don't do that and the ratings agencies hit them."

The question is, what is the winning scenario, he remarked.

Even with all the pressure, the Philippines, like the overall market, is trading at tight levels.

"The Philippine index is 428 [bps] over today [Thursday]. Brazil is 426. If I have to choose one, guess which one I'm going to choose.

"Brazil is not a perfect country but I think they have more going for them than the Philippines," he told Prospect News.

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