Optimists versus pessimists in emerging markets; quiet session; Indonesia gone for now

By Paul A. Harris

St. Louis, March 28 - With many markets in Europe and Asia closed for the Easter holiday and U.S. Treasuries continuing to travel a very rocky road, the spin on Monday's emerging markets varied from source to source.

By turns some saw the glass half full (i.e. "the market may now be oversold") while others advised that it may still be wise to stand clear.

On the half-full side, the market appeared to be holding water, at least on a spread basis. Late Monday one source had the JP Morgan EMBI plus index one basis point tighter at 393. Although not long afterward another source saw it close one basis points wider at 395.

On the half-empty side Indonesia pulled its benchmark-sized global bond deal, although it is not expected to stay gone indefinitely.

Call it a "correction"

On Monday Prospect New was unable to locate a single source who was inclined to quibble over whether or not emerging markets are undergoing a correction.

Disagreement did exist, however, as to the correction's likely depth and duration.

A sell-side source said that some bonds were seen to improve during the quiet session, and added that on a spread basis emerging markets were down but not down as much as Treasuries.

The official said that although Brazil's benchmark bond due 2040 had been down by as much as a point on Monday, late in the session it had improved to close down only 0.40.

"Brazil came out and said that they were not going to renew their IMF agreement," the official commented. "Then John Snow came out with a lot of nice, glowing things to say about the Brazilians. The market moved up a little on the back of those comments.

"But it has been a pretty dead day, with London and everybody else closed."

This sell-sider was certainly in no mood to argue as to whether or not a market correction is underway. Like everyone else who spoke during the session the source seemed to accept that as an accomplished fact.

"Is this correction overdone?" the official asked rhetorically. "I think probably so, at this point.

"Emerging markets has just reacted to what has happened to other markets.

"Now it's the end of the quarter. Payroll numbers come out at the end of the week. I don't think people are going to step up and get heroic."

Real money remains in position

The sell-sider specified that the day's trading - meager though it was, and almost totally focused on Latin American names - was "two-way" trading.

"In general it feels like it's harder for the market to go down from here in the absence of any new news from the outside," said the sell-sider.

"It feels like there is support at the present levels.

"We have not seen a lot of real-money selling throughout this whole downturn. Real money is probably positioned more or less the way it wants to be, anyway.

"It has been the trading accounts that have really been pushing the market around. Until they decide that they want to come in and buy again I think we're just going to sit here."

Asia in the lead this time

One curious facet of the present sell-off in emerging markets, the source said, is that because it was issued at the very top of the market, recent new Asian paper appears to have led the sell-off.

"If you look on a U.S. dollar price-basis at the Brazil 2040 - which admittedly is a 35-year bond that gives an exaggerated price move relative to a 10-year bond - the higher yielding Asian stuff in some cases has widened a lot. And that is true for both the higher yielding sovereigns and the corporates. Indonesia is probably 25 to 30 basis points wider than its recent levels. The differential with the Philippines is probably a little wider than that.

"Several new Asian issues priced just at the top of the market and the market turned around pretty quickly right after that. The new issues tend to be the first ones to take it on the chin when you get a market correction.

"But the non-investment grade side of Asia has certainly been more in line with the rest of the EM news than is usually the case.

"That said, the higher quality paper, Korea and China, has not widened that much."

Indonesia backs away

One piece of news that did emanate from the quiet Asian markets on Monday was that Indonesia has postponed its benchmark-sized deal, which late last week had heard to have only been delayed by the current sell-off in emerging markets.

But the offering is expected to return.

"Indonesia still needs to get a deal done," an informed source told Prospect News.

The country was in the market with $1 billion to $1.5 billion of notes. Rough guidance of U.S. Treasuries plus 240 to 260 basis points had been heard.

Deutsche Bank Securities, UBS Investment Bank and Citigroup had the bookrunning mandate. Credit Suisse First Boston and JP Morgan were the co-managers.

"Asia has been pretty hard hit," said a source familiar with the Indonesia deal. "I'm not sure there was a price where they could have done $1 billion, unless it was a pretty stupid price."

Treasury sensitivity

The sell-side source, who maintained throughout the conversation that the present emerging markets scenario is a "glass half-full" story, conceded that what may eventually emerge from the present sell-off is a new paradigm for issuers.

The official had no difficulty identifying the culprit in this scenario: the U.S. Treasury market, with its widely followed 10-year bond selling off again on Monday.

"Emerging markets thinks of itself in terms of the spread to Treasuries - even for the higher yielding issuers," the source said.

"Brazil, for example, tapped its 2015 at a yield of 7.90%. Now that yield is 9.20%. They're not going to just turn around and be as happy with 9.20% as they were with 7.90%. Maybe over time they will come to the conclusion that they are never going to get back to 7.90%, and that 9.20% is the new level. But you don't make that transformation instantly.

"And even if they did the market is not going to take it at 9.20%."

The official also specified that, at least in the Latin American realm, the higher-rated paper has also been hit.

"The Mexico 2015 has widened by close to 50 basis points," the official said. "That's approximately 50% of the spread.

"Mexico has a high correlation with U.S. automotives. If automotives are 100 to 150 wider that has more of an impact on Mexico than it does with U.S. bank paper.

EMBI may be heading for 400

Elsewhere, an analyst who spoke to Prospect News on Monday did not seem to be seeing the emerging markets glass as a half-full one - at least not yet.

The analyst, who spotted the EMBI plus one basis point wider at 395, pointed out that the widely followed index is edging close to the 400-mark, and added that that is significant.

"I think that makes the market very uneasy," the analyst said. "And the unease is still pretty evident.

"If you look at price action during the day most prices were testing lows, and moving a little further off, especially in the high beta names.

"There was a lot of defensive action in the U.S. Treasury market again. I think that is the key to everything. We're going on at 4.64%, borderline 4.65%. I don't think that is a very desirable level for emerging markets at this point. If we go beyond that we should see a little more price correction going on in synch with what's going on in the Treasury side."

Liquidity in short supply

The analyst said that, along with the chop in Treasuries, the liquidity picture in the emerging markets appears to be undergoing a shift.

"I think illiquidity is the most noteworthy event in the market right now," the analyst said.

"Running up into the Easter holiday you had very wide bid-offer spreads in the second-tier credits - that is, beyond Brazil and the most liquid bonds in the other larger names throughout Latin America.

"That continued into Monday. It isn't odd, but it becomes an obstacle in the way of the market righting itself.

"The overall change on the day, in terms of spread-widening, doesn't really tell the liquidity story."

To illustrate, the source spotted Panama's bond due 2027 at 104 bid, 107 offered, and the Peru bond due 2033 at 100 bid, 101.50 offered.

"It says a lot about the market. It says that the market is not willing to take a lot of risk at this time.

"That's reflected in those very wide bid-offer spreads."

The analyst said that the present situation defies easy explanations.

"Normally in a sell-off you get a pullback in the high beta names," the analyst said. "Then you have a catch-up move from the double-B credits and higher.

"This time, although high beta has led, you had some marked underperformers which normally are not associated with this type of move.

"Specifically I would highlight Colombia, which has been the underperformer among Latin American countries in the present sell-off. That's not the norm, because it is a double-B credit. But it has been underperforming significantly since this move started."

One explanation, the source said, is that the real money was underweight Colombia going into the present sell-off.

"A lot of the larger dedicated EM shops have been underweight, which means that it really has no support when the people who are short-selling target it."

The source added that the Colombia story may also be exacerbated by headline news.

For example, the analyst said, the courts in Colombia are now mulling whether or not constitutional changes voted by congress, paving the way for the re-election of president Alvaro Uribe (who presently has support of 67% of the public, according to polls), will stand.

Also, despite a pending summit to be held by Venezuelan president Hugo Chavez, which Uribe is expected to attend, tensions between Venezuela and Colombia turned up a notch when it was learned that Chavez authorized the purchase of weapons from the Russian Federation - weapons that some observers fear will find their way into the hands of Colombia's Leftist rebels.

"The Colombia-Venezuela situation was somewhat defused by a meeting between Uribe and Chavez," said the analyst. "But it is still something that could potentially flair up, going forward.

"When you are dealing with Chavez you never know exactly what he is planning. And it is widespread news that Venezuela has acquired somewhere in the neighborhood of 100,000 Kalashnikov rifles from Russia. People naturally wonder where those are going to end up."

Braskem mandates ABN, Citi

As to the day's only Latin American primary market news, that Sao Paolo Brazil-based petrochemical company Braskem SA has mandated ABN Amro and Citigroup to lead an upcoming bond issue, the emerging markets analyst said "Perhaps," but added that the deal is not likely to take shape in the immediate future.

"The market does not seem to be in a bidding mode right now for any type of paper," the analyst said.

"Even triple-A names would be included; you could float triple-A paper because it's a different type of audience. But for the double-B credits and below it would be very difficult to get off an issue at this point."

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