Emerging market debt sees slight uptick during slow session; oil briefly passes $70 per barrel

By Reshmi Basu and Paul A. Harris

New York, Aug. 30 - Emerging market debt moved higher Tuesday on a U.S. Treasuries rally.

Increased speculation that the economy in the United States may slow pushed down Treasury yields, which in turn helped emerging market paper.

The Federal Reserve is concerned about rising inflation and soaring oil prices, according to the minutes from its August meeting.

The Fed said Tuesday that "higher and rising energy prices were adding to pressure on overall inflation, and energy prices would probably feed through to core measures of inflation."

It also added that: "An increase in inflation from recent rates could have especially adverse effects on longer-run economic performance."

Those comments, along with the rise in oil prices, raised expectations that higher energy costs could slow the U.S. economy.

That sentiment helped the yield on the 10-year Treasury note hit a seven-week low of 4.10% compared to 4.17% on Monday.

"Essentially, what's occurring is that the market is sensing that the slowdown theory in the U.S. continues to advance," remarked Enrique Alvarez, Latin America debt strategist for research firm IDEAglobal.

"That in turn is affecting U.S. Treasury rates and that is favoring Latin America."

During the session, the Brazil bond due 2040 moved up by 0.30 to 118.35 bid.

A trader described the session as "slow with a slight uptick" and "very few players."

Slowdown scenario

Nonetheless, Alvarez noted that there are some stingers within the slowdown scenario. After all, a slowdown will feed into Latin America.

"Latin America is not immune to $70 oil prices and we should see some sort of effect there.

"And if you take a look at Asia, Indonesia seems to be making a lot of noise with a very large currency depreciation on the day," he said.

The rupiah briefly dove 9% against the dollar to a four-year low on concerns of an economic implosion. The rupiah has come under pressure as oil prices have dented the country's balance of payments.

Furthermore, Alvarez noted that while Latin America may not fall victim to a contagion effect, investors should look to Indonesia as a warning.

Record energy prices

Oil prices hit a high of $70.85 per barrel during the session before settling at $69.81, up 3.9%.

"Overall the situation in oil just keeps on going from bad to worse as far as prices are concerned," observed Alvarez.

"Latam favors... the scenario where these very high oil prices produce a slowdown in the U.S." he added.

"However, you have to look at the domestic side of the equation and that does not necessarily mean the continuation of these very tight spread levels."

Spate of U.S. economic data

Investors will return to a much more complicated scenario next week as a slew of directional indicators are released this week, such as the releases of revised gross domestic product on Wednesday and non-farm payroll numbers on Friday.

Also, Thursday will see the report on the core personal consumption expenditure price index and the factory sentiment index.

But Alvarez remarked that investors will mostly be focused on surging oil prices.

"As long as the U.S. continues to buy into the theory that we are heading into a slowdown and the Fed is going to be essentially forced into a corner to take its foot off the accelerator pedal - that's going to be a positive for the market.

But he warned that high oil prices could result in risk aversion, which would be a danger to the Latin American region.

"They [investors] are going to have to calibrate a very difficult circumstance," noted Alvarez.

"There is a lot of liquidity out there. There will be a lot of liquidity for the market come September and October when we have such large amortization and coupon payments."

But he cautioned that there are a number of warning signs that investors need to heed.

Mobile TeleSystems slips

Russia's Mobile TeleSystems OJSC announced that revenues were up 35% year-on-year to $1.237 billion - but the impact on its debt was negligible.

The company's 8 3/8% bond due 2010 was seen at 107 1/8 bid, down 0.02, according to a trader.

The trader added that there were not enough players for corporates to move on headlines.

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