Brazil leads emerging markets higher; China Development Bank prices $1 billion 10-year notes

By Reshmi Basu and Paul A. Harris

New York, Sept. 29 - Emerging market debt continued to jump higher Thursday led by Brazilian bonds, which saw gains on positive developments for the government. Also high oil prices gave support to the asset class.

Meanwhile in the primary market, China Development Bank priced a $1 billion issue of 5% 10-year notes on Thursday at an 86 basis points spread to U.S. Treasuries.

The notes priced inside of the Treasuries plus 90 basis points price talk.

A market source said that there was $6 billion in the books.

Barclays Capital, BNP Paribas, Citigroup, Goldman Sachs & Co., HSBC, JP Morgan, Merrill Lynch & Co. and UBS were the bookrunners.

And Bank of India priced a $250 million issue of 5 3/8% five-year senior unsecured fixed-rate notes (Baa3/BB+) at mid-swaps plus 85 basis points on Thursday.

The issue priced on top of the price talk.

Barclays Capital ran the books for the Regulation S issue. Deutsche Bank and HSBC were joint lead managers.

The notes were priced off of the issuer's $1 billion medium-term notes program.

Brazil up on Lula's win

Government-backed candidate Aldo Rebelo emerged as the winner against opposition coalition candidate Thomaz Nomo in a run-off to become the president of the lower house.

The market saw Rebelo's win as a sign that the lingering political crisis in Brazil is disappearing, said a market source, who added that it means president Luiz Inacio Lula da Silva has become a little more insulated from opposition attacks.

The election of a Lula ally helped Brazilian bonds move higher and perhaps, more importantly put to bed fears of an impeachment, remarked the source.

In the last several months, Lula and his Workers' Party came under attack for allegations of illegal campaign funding and bribing congressional leaders for votes.

During the session, the Brazil bond due 2040 gained 0.90 to 122.40 bid.

High oil prices helped Ecuador and Venezuela. The Ecuador bond due 2030 gained one point to 94.10 bid. The Venezuela bond due 2027 surged 2.85 to 118½ bid.

Other winners from Latin America included Colombia, which saw its bonds due 2012 add 0.20 to 120½ bid,

Meanwhile Indonesia's parliament agreed to a proposal to cut fuel subsidies, which is resulting in protests. The change is expected to take place before Ramadan.

A source said that the market had already priced in the subsidy cut. Furthermore, the market is more concerned about next month's likely $1 billion new bond issuance than protests, added the source.

In trading, the Indonesian bond due 2015 added 0.44 to 100 bid.

Cautious optimism

The tone of the market can be described as "cautious optimism," according to a debt strategist, who noted that "yields are low and spreads are tight worldwide."

"Nothing seems to want to sell off, now does it?

"The value argument is that you still got a story that you got positive long-term improving fundamentals - that's really your basic case for having money invested in the EM asset class," he said.

"And leaned against that is oil, global imbalances, election cycles. And if you think that's all noise, no worries," he added.

Even Mexico's central bank governor Guillermo Ortiz believes that it is noise indeed, noted the strategist.

He offered this anecdote. When Ortiz was asked about the external rate environment, he answered: "No worries. Japan's not going to raise rates. Europe's not going to raise rates. U.S. is slowing. No worries."

Last week, the Bank of Mexico last week cut its benchmark-lending rate for a second time in two months to 9¼% from 9½%.

"I think carry [trade] is still king and people aren't worried about anything in particular" remarked the strategist.

Furthermore, the strategist asked: "Why are world-wide real yields so low?"

For instance he noted non-emerging market United Kingdom as an example.

"It did borrow money for 50 years at 1.1% real interest rate last week. Big size, too. And I went, '1.1%- that's the return on capital? That's what we got going for us?'

"That's weird. If you think about it, return on labor is not that great because we dumped all these new guys into the world labor market," he noted.

Additionally the strategist found the scenario perplexing given that real wages are flat or falling. "Real return on wages, like zip. Real return on capital - one. What kind of capitalism is this?"

He added that the only ones making money were oil producers.

Trigger for market correction

The strategist said that liquidity or technicals rather than fundamentals in emerging markets would trigger a market correction.

"We might have an air pocket here where the U.S. consumer actually does slow down. We could have a soft Christmas," he remarked.

If that does happen, the Federal Reserve may pause its current monetary tightening campaign,

"You might see an energy-directed investment boom starting to take root in all sorts of places and some serious corporate money starting to get spent on projects," he told Prospect News.

If there are signs that the U.S. economy is beginning to improve next year, the Fed may resume tightening, which may come as a surprise, especially to those who hold levered positions.

"There's not a lot of emerging market CDOs. But there's a lot of CDOs. And the triple-A tranches are 10-times levered. And if your funding costs go up, you are going to have to sell those tranches to someone," he told Prospect News.

"And that could lead to a cascade of repricing throughout the whole world markets."

The strategist said his impression is that it is a very liquid world.

"It's too liquid for the Fed. The Fed wants to take some of the liquidity away. And will continue to do that."

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