Emerging markets drops with equities; Argentina, Brazil lead losers; primary looks to '08

By Aaron Hochman-Zimmerman

New York, Dec. 17 - Emerging markets continued to sink in the thin liquidity of the pre-holiday season.

Spreads widened and prices fell in the wake of an equity drop that could not be prevented by a $20 billion injection into the money markets by the Federal Reserve.

Argentina suffered the most, seeing its discount bonds due 2033 lose 1.3, while often stable Brazil saw a 0.75 drop in its sovereigns due 2040.

The primary was full, but only with speculation about the first quarter of 2008.

There is a lack of consensus about the likely tone and volume of January's primary, but many agree that "the big question here is the U.S. economy," as a syndicate official said.

Next year will likely be split into two distinct halves, a market source said.

The first half will be much like the current environment, but the second half of 2008 will show a bounce back, with room to improve left by the early widening, the source said.

In addition, even if the Fed cuts interest rates down to 3.25%, a rebound in the dollar will stifle the gains in other currencies, the source added.

"It feels, to me, completely intuitive that we can get through this," a trader said.

There may be a time when people will say: "'Remember those bad old days?' but we will be lucky to be there," he said.

There are concerns that former Fed chairman Alan Greenspan laid the foundation for the current problem after the attacks on Sept. 11 and the bursting of the technology bubble, the trader said, and policymakers must be vigilant not to "lay the foundations for a different problem.

"It seems to me that we're very generally in that sort of situation," he said.

The word "stagflation" is beginning to creep up, he said, but "I don't think people want to talk about it."

Still, there is a good chance that the market will look back this coming summer and say: "We got away with that," he said.

Monday, despite the Fed auction, volatility spiked in the morning, then tempered to finish higher by 1.25, according to the VIX index which closed at 24.52. The index is the accepted measure of market volatility.

The difficult day saw emerging markets widen by 7 basis points to leave the sector with a spread of 229 bps, according to JP Morgan's EMBI+ index. The EMBI+ determines the amount of extra yield investors require to hold money in emerging markets debt.

Argentina, Brazil step back in LatAm

"I didn't even want to look [at credit]," a buysider said after seeing the performance in equities.

"Liquidity has dried up in the last couple of weeks," he said.

Yet, even the liquidity injection from the Fed did not help prop up the emerging market secondary.

Argentina's 8.28% discount bonds due 2033 mimicked Friday's unimpressive performance by dropping 1.3 to lead the emerging markets losers. The bonds were quoted at 94.3 bid.

Venezuela is on the verge of easing back from some of the growth it has seen in 2007, the market source said.

Still, high oil prices may act as a safety net against any other market breakdowns, the source added.

The 9.25% Venezuelan sovereigns due 2027 held unchanged at 99.5 bid.

Along with Bolivia and Chile, Brazil will fund a project to build a highway connecting the Atlantic and Pacific coasts of South America by 2009.

The $600 million effort will add to existing roads which will complete a highway between Santos, Brazil and Iquique, Chile.

The Brazilian 11% bonds due 2040 dropped off 0.75 to 132.85 bid, 133 offered. The bonds due 2037 fell 0.06 to 112.5 bid.

Vale jumps around as shipments restart

Meanwhile a trader saw Companhia Vale do Rio Doce's Vale Overseas' 6 7/8% notes due 2036 "pretty active, as a lot of the metals mining world have been.

"Back in the summer it was Alcoa, then in the fall it was Xstrata and BHP, and now it's CVRD. The sector in general is trading about the same."

A market source saw the bonds of the Brazilian iron-ore producer - the world's largest producer - gyrating around in busy trading, at levels as wide as 255 bps over and as tight as 214 bps over, though for much of the day, they stayed in the same 240 bps area at which they had finished on Friday.

Over the weekend, Vale began restarting shipments of iron ore from one of its ports which had been closed since a Dec. 8 shipping accident at the facility. Loss of the port and inability to find another way of completing the scheduled shipments had forced the company to declare a "force majeure" on some ore shipments to China, causing a shortage of the metal over there.

Debate over primary in '08

No attempts were made to test the waters of the primary on Monday, but there is a group of investors who are prepared for "a rush coming through in January," a syndicate official said.

The pipeline may open up "once people get used to the idea that it's going to stay a little volatile," he said.

"It's going to be hard," said a buysider, to open up the primary in the new year.

A frequent issuer will have to lead the way, he said.

"If high yield doesn't open at all, then I don't think emerging markets will print anything," he said.

There is also a question of how the market will react to a lot of supply, he said.

Rather than set sail on the global markets, many of the more stable economies will look internally to raise capital.

"Mexico and Peru have obviously been changing their deals from external to local," he said.

The local deals typically have "less size," he said, but "those markets have more resilience."

"I think it's probably going to be worse for EM," a syndicate desk official said about the early part of 2008.

"Look at how much high grade has had to pay," the official said.

"I think our issuers are in denial," the source said over their exposure to the subprime crisis.

Still, printing new deals is becoming more necessary for certain issuers.

"I think as you get into 2008, that is part of their plans," the official said, adding: "the Latin issuers are the less needy of the regions."

If the Eastern European and Asian issuers are forced to bring deals to market at elevated yields the Latin issuers will have to offer similar amounts. "They don't benefit by waiting," the official added.

"Still yields are close to all-time lows," the official said concerning the top-tier issuers. It is the lower-tier borrowers that may be forced into an unfavorable situation.

Emerging Europe continues account squaring

Emerging Europe continued last week's pattern of light selling and low volumes.

"It all opened a bit weaker and that's the way it's remained," a trader said.

"There are a few guys out there that are essentially done and there's a few guys trying to square up positions," he said.

"We can drift a bit lower without anything to change its style," he said of expected market activity in the last week before the holidays.

In Russia, president Vladimir Putin announced his intention to become prime minister when his term expires in March. Putin's chosen successor, Dmitry Medvedev of also of the United Russia party, is assumed to win the presidency.

According to the constitution, Putin cannot run for a third consecutive term in 2008, but can run again in 2012.

Also, the first shipment of Russian nuclear fuel arrived at the reactor in Bushehr, Iran.

Western powers and the United Nations have expressed concern over the assistance Russia has given to Iran for a nuclear program it claims is for civilian use only.

The Russian government bonds due 2030 gained 0.15 to 113.55 bid, 113.65 offered.

The European Union urged Turkey to use restraint in its air campaign against the Kurdistan Workers Party (PKK) in order to preserve regional stability.

Iraqi authorities reported air attacks on 10 villages resulting in one civilian death.

The Turkish sovereigns due 2030 were lower by 0.2 at 157.00 bid, 157.25 offered.

Asia mixed to lower

"Everything's a bit weaker today," a syndicate source said of bonds in Asia, which followed equities lower.

"I've seen very little flow," he said.

Still, some Asian issues were able to find buyers to support small gains.

In the Philippines, the central bank announced that reverse repurchase agreement lending to commercial banks, thrift banks and rural banks grew by 7.1% year over year in October compared to 6.9% in September.

Also, negotiations between the government and the rebel group, the Moro Islamic Liberation Front (MILF) broke down over the weekend.

MILF accused the government of altering the agreed upon terms of a plan to allow the breakaway group an Islamic homeland in the southern Mindanao region.

The two sides did not meet as scheduled in Kuala Lumpur, Saturday.

The Filipino sovereign bonds due 2030 gained 0.5 to trade at approximately 134.5 bid.

Indonesia's government bonds due 2017 held flat at 103.5 bid.

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