Emerging market debt rides high on U.S. Treasuries rally; Philippines to retap 9½% bonds due 2030

By Reshmi Basu and Paul A. Harris

New York, Aug. 31 - Emerging market debt soared on day two of a U.S. Treasuries rally.

And in the primary market, the Republic of the Philippines is expected to tap its dollar-denominated 9½% sovereign bond due Feb. 2, 2030 shortly after the three-day Labor Day holiday recess in the United States.

Treasuries rallied for a second day on speculation that the Federal Reserve may pause its current monetary tightening campaign. Some investors are betting that consumer spending will slow down as oil prices take a bite out of the U.S. economy.

The economy faces challenges from rising oil prices and from the effects of Hurricane Katrina.

And surprisingly weak economic data released Wednesday added support to an economic slowdown scenario. The National Association of Purchasing Management-Chicago said the Chicago purchasing managers index dropped to 49.2% in August, the worst reading since 2003.

"When there is situation when you're a perceiving a potential meltdown or correction, you go to the [U.S] bond," said a Latin America debt strategist at Refco EM.

"That's what we've seen today [Wednesday].

"The 10-year...is close to 4%. It was three or four weeks ago when we were close to 4.35%/4.40%."

During Wednesday's session, that Treasuries rally fueled emerging markets, said sources.

The JP Morgan EMBI Index was up by 0.70% while its spreads were slightly tighter, said a trader.

"Brazil is very strong," said the strategist. "Venezuela is strong. Colombia was strong. Mexico was also strong. The whole region was on fire," he observed.

Meanwhile, investors have turned their attention to the devastation left by Hurricane Katrina, which has taken some of the focus off the corruption scandal in Brazil and the administration of president Luiz Inacio Lula da Silva

"Without any further news, we're going to see this whole process of trying to implicate Lula die," noted the strategist.

Indonesia's inflation scares

Over recent sessions Indonesian asset prices have been hit by inflation scares triggered by rising crude oil prices. The Indonesian rupiah exchange rate widened to 11,500 against the dollar, Indonesian stock prices fell and sovereign and corporate dollar-denominated eurobonds also widened.

In response the Indonesian central bank raised its benchmark interest rate by 75 basis points on Tuesday to 9½%. The government also reined in fuel subsidies and increased bank reserve requirements.

The result, according to a trader who focuses on high yielding Asian credits, was a dramatic improvement Wednesday in the prices of Indonesian and other high beta Asian bonds.

"Everything including the rupiah, the Jakarta composite index and the U.S. dollar-denominated bonds have come back with a vengeance," the trader said.

The source said that Indonesia's dollar-denominated 7¼% bond due 2015, which had traded as low as 96 bid in Asia, was at 98.875 bid in U.S. trading late Wednesday afternoon.

Indonesia's 'drag' effect

The trader confirmed what Prospect New had been hearing from sources throughout the week - that the sell-off in Indonesian assets triggered by oil price-driven inflation and foreign exchange scares has been pulling other high yielding Asian paper down with it.

The trader said that, as valuations in the secondary market widened out, there began to be uncertainty about all of the deals that are coming next month. In some cases, the trader added, talk on those deal widened in order to make them competitive versus the secondary.

"One thing begat the other," the trader said. "Yields rose in the secondary and then people started talking new issues cheaper.

"For a couple of days it looked like we could have some sort of mini-contagion emanating from Indonesia and spreading through the rest of high yield Asia.

"But now there are nothing but buyers."

The trader added that one factor that definitely contributed to the sell-off was reluctance on the part of accounts to show a lot of Indonesian risk going into the end of August.

"Now that the month is over they're starting to buy it back with a lot more confidence," said the trader, adding that a similar scenario played out with Philippines paper.

Search for yield

The trader commented that the market is much healthier now than it has been for the past few weeks.

The strategist added that as the summer session comes to an end and liquidity returns, the market may see higher returns.

"There's going to amortization and coupon payments," remarked the Refco strategist.

"But also there's not a lot of alternatives to put your money out there in the world markets. People continue to see emerging markets as a way to get a higher yield with strong fundamentals."

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