Emerging market debt follows U.S Treasuries bounce; Asia steady despite deadly tsunami

By Reshmi Basu and Paul A. Harris

New York, Jan. 3 - In the first trading day of the new year, emerging market debt closely tracked an uncertain U.S Treasuries market.

Treasuries had a difficult time making up their mind Monday, but eventually retraced their losses and ended the day with small gains.

The yield on the 10-year note stood at 4.21% from Friday's close of 4.22%. At one point, the yield touched 4.26% on positive manufacturing data. The Institute for Supply Management's index rose to 58.6 in December from 57.8 in November, coming above expectations.

Those numbers helped spark concerns that Friday's non-farm payroll number may come in stronger than expected, initially hurting the Treasuries market.

Besides U.S Treasuries, paper from Latin America has also been paying attention to movements in local currency markets, according to Latin America debt strategist Enrique Alvarez at think tank IDEAglobal.

"I think you still have a very linked market to what's going on in currencies in Latin America," noted Alvarez.

"Those were off a little bit, headed by the Brazilian real."

During Monday's session, the Brazil C-bond fell 0.063 to 102.312 bid while the bond due 2040 slid a quarter of a point to 118.45 bid. The Mexico bond due 2009 was down 0.05 to 122.30 bid. The Venezuela bond due 2027 dropped ¾ of a point to 104¾ bid.

"I think the week essentially boils down to what is going to be done on the Treasuries' side - in particular what comes out of non-farm payroll numbers on Friday," said Alvarez.

"Until then, I think you are going to have a wind up period where the market is still very positive, but needs to see fresh data," he commented.

Another factor for the market will be new issues in the pipeline, according to Alvarez.

"There were plenty of rumors in December about local currency issuances. I'm sure some of that will actually materialize this month."

Brazil is expected to tap the market with a local currency deal sooner rather than later in January.

Asia's devastation

The Asian market was quiet during Monday's trading session. Spreads were flat from last week, according to a market source.

Standard & Poor's said that Asian countries hit by the deadly tsunami would not see their ratings changed. The death toll stands at 155,500.

During Monday's session in Asia, the Indonesia bond due 2014 was quoted unchanged at 100 bid. The Philippines bond due 2014 was also unchanged at 98¼ bid.

Asian speculative-grade issuers, Pakistan, Indonesia and the Philippines, are "fairly rare, but also pretty expensive," said the sellside source.

"Indonesia is still trading at pretty tight levels - even after the tsunami.

"People think that Indonesia has needs for the year and will certainly issue this year," commented the source.

Indonesia is expected to issue at least $1 billion in 2005, said the source.

"The news of the tsunami has not hurt Indonesia's secondary levels at all. Some people are saying that, if anything, there is a 'sympathy bid,' that becomes factored in.

"And a sympathy bid is one thing, but a sympathy bid at 250 basis points over Treasuries is something else," noted the sellside source.

Indonesia is trading in the mid- to upper-200s. By comparison the Philippines is trading in the high 400s, according to the source.

The Philippines will likely issue $4.5 billion in new paper in 2005.

Also brewing in the pipeline, Pakistan is expected to begin marketing a benchmark-sized five-year Islamic bond (B2/B+) next week.

The deal is expected to be well received.

Citigroup and HSBC will run the books.

The year ahead in EM

The burning question in emerging markets is just how U.S Treasuries will fare in 2005.

"EM was the top performing bond group for 2004. It beat junk bonds," said sellside source.

"Barron's did an article a week ago saying that you have to look for the higher yielding securities, arguing that you don't quite know what's happening with Treasuries, but you have to figure that they are going higher," the sellside source told Prospect News.

"I guess the question is: 'Are they going to 4¾% or 5¾%?'"

Emerging markets - and most fixed-income markets - have been set up for a reasonably benign Treasury outlook, said the source.

"I don't think that the emerging markets are set up for a 5½% Treasury at the end of 2005. It has a much more moderate Treasury forecast priced in."

As a result the story would be different if Treasury rates move substantially higher than market expectations, observed the sellside source.

"But with the more benign outlook people are figuring that you still buy the higher yielding asset classes.

"And emerging markets is a market where, in general, credits are getting upgraded rather than downgraded," said the source.

The average rating in emerging markets is substantially higher than high yield, noted the source.

"And if you think that commodity prices are going to remain reasonably strong, that will tend to benefit emerging markets."

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