EM zig-zags with U.S. stocks; Venezuela, Colombia, Brazil gain; primary optimism waning

By Paul Deckelman and Aaron Hochman-Zimmerman

New York, Aug. 1 - Emerging markets bonds were playing "following the bouncing ball" all day - the ball, in this case, being the U.S. equity markets, which were gyrating up and down with abandon, as investor concern about risk and more subprime mortgage meltdown angst staged a tug-of-war with bargain-hunters looking to take advantage of the financial markets' downturn since mid-July.

In the end, the latter won, as equity markets first posted early gains, then surrendered those gains on the news that Bear Stearns & Co. was blocking investors from withdrawing money from one of its funds because of losses in the credit markets, but then came back late in the day to end higher, with the bellwether Dow Jones Industrial Average closing up 150 points, getting a little late help from positive earnings news from entertainment giant Walt Disney Co.

That see-saw behavior was in turn matched by emerging debt, which tracked stocks up and down. The key measure of emerging market investor tolerance or aversion, the average EM debt spread over U.S. Treasuries tracked by JP Morgan & Co.'s widely followed EMBI+ index - seen as a proxy for overall EM market performance - first widened out to around 222 basis points from the index's opening levels at 219 bps - but, with U.S. stocks leading the way, that had tightened by 4 bps on the day by the end of the session to 215 bps. Meanwhile, the yield on the benchmark 10-year Treasury issue rose 4 bps from Tuesday's late level to 4.79%.

Among the big movers seen in EM bonds on Wednesday were Venezuela, Colombia and Brazil, as well as Argentina's dollar-denominated external debt. In the Asian segment of the market, Indonesia's sovereign bonds got a boost as Moody's Investors Service said it would consider a ratings upgrade for Jakarta's paper.

Meanwhile primary market optimism was seen trailing off as a pipeline clogged with fear refuses to let any liquidity through.

"There is a ton of fear ... Just not seeing much capitulation yet, but you can feel it lurking" an analyst specializing in Latin America said about investors who may be ready to run from emerging markets.

"We're a little worried," said an emerging markets syndicate desk official who specializes in European markets.

"I'm seeing less optimism, but it still exists," the official added.

A market source specializing in Latin America suggested the current situation could be worse, but is still concerned about where it is heading.

"Our market is in better shape than most credit markets, given strong technicals and strong fundamentals," the source said.

"However, it will be very difficult for our market to sustain rallies while the world is fearing more hedge fund failures and continued weakness in broader credit markets," the source added.

In the short-term the source feels "bearish on the market as high yield and high grade issues will continue to weigh our market down even though we do not have their problems," the source said.

The Latin America analyst said cash is being put to work, but away from new issues.

"We've seen plenty of bottom fishers," the analyst said. "Liquidity is surprisingly good."

Latin bonds bounce with stocks

A New York-based trader in Latin American debt said his market was "all over the place - it ended up closing 10 to 20 [bps] tighter across the board."

Among the "big movers" of the session, he saw Venezuela's bonds about 21 bps tighter, and Colombia's and Brazil's both 19 bps tighter.

"They were up, down, up, down all day, very volatile," before finally making their last move, to the upside, late in the day.

"They went from a very positive equity market, to very negative all day, and when Disney came out with earnings late in the day, that was the end - the Dow wrapped up 150 points, and everything else tightened along with it."

Venezuela's benchmark 9¼% dollar-denominated bonds due 2027 were seen having jumped 1¾ points to close at 106.25. Those bonds had quickly raced out to a 1¼ point lead, only to surrender those early gains as the market started to pull back around midday in the Western Hemisphere, but then came roaring back to end higher.

Meanwhile the cost of Venezuela five-year credit default swaps was seen having fallen by 30 bps to 355 bps.

Argentina - whose debt has underperformed even fellow high-beta name Venezuela's this year, posting sharp losses in the 20% area last week in particular against the backdrop of an overall EM bloodbath - was seen mixed in Wednesday's dealings.

While Buenos Aires' 8.28% dollar-denominated bonds due 2033, like Venezuela, rebounded from its early losses to finish quoted up more than 1½ points at 84.75, its local-denominated bonds were seen lower, in line with a decline in the peso. Those local bonds were seen down some 1.7% on the session, with the discount bonds seen among the worst laggards.

Brazil's widely traded 11% dollar-denominated bonds due 2040, considered the most liquid emerging markets issue, was seen having jumped more than 1 3/16 points, rising to 129.875.

The cost of a five-year CDS contract linked to Brazilian bonds was seen having declined by 20 bps to 114.5 bps.

Indonesia leads the way in Asia

In Asian dealings, Indonesia's bonds got a boost amid a generally weak market after Moody's Investors Service said that it would consider raising the country's sovereign B1 rating.

The ratings agency cited the progress the country has made in improving its debt ratios as one factor in its decision.

"Indonesia faces very good prospects for near-term growth in capital formation," Moody's said in its announcement of the ratings review, although it also added the caveat that "work may be needed on the structural reform front to improve labor regulations, tax administration and legal certainty."

Besides monitoring the progress the country makes in attracting overseas investment, Moody's said it will scrutinize how it meets its budget targets.

Indonesia's benchmark 2035 bonds were trading lower before the Moody's announcement, but rose some ¾ point on the news to 112.75.

However, with the overall market weakened by uncertainty over whether the U.S. subprime lending problems would spread to other segments of the debt world, the cost of a five-year CDS contract for those bonds was seen having jumped out about 20 bps on the day to 223/233 bps.

A similar 20 bps price jump took the cost of five-year CDS contract on Philippine debt to 225/235 bps.

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