Investors on defensive ahead of Friday's job numbers; Moody's upgrades Mexico

By Reshmi Basu and Paul A. Harris

New York, Jan. 6 - Emerging market debt continued its losing streak for the third straight day Thursday as investors eyed Friday's non-farm payroll numbers. But there was an afternoon trading up tick for Mexico on a ratings upgrade.

In recent sessions, there have been more sellers than buyers as noise over higher interest rates becomes louder.

"It's all happening because of all the news related with the Fed," said a sellside source. "People are expecting U.S Treasury rates to go up, and they are adjusting their portfolios to that future event."

During Thursday's session, the Brazil C bond lost 0.188 to 100.562 bid while the bond due 2040 was down 0.40 to 113.90 bid. The Colombia bond due 2009 fell half a point to 113½ bid while the bond due 2012 slid 0.85 to 112.90 bid.

The Ecuador bond due 2030 lost 0.10 to 85.15 bid. The Venezuela bond due 2027 slipped half a point to 102 ¼ bid.

Overall, the JP Morgan EMBI Global Diversified index widened four basis points to 383 basis points.

Hedge funds and real money accounts made up the sellers during Thursday's session, said a buyside source.

"It was a little bit of a seesaw," said Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal.

"In general, it is a market that still seems to be a little skittish. I think there are still some relative fears on what could occur on the Treasury curve as a consequence of tomorrow's [Friday's] NFP numbers. I think people are very hesitant to accumulate any more risk and are on the defensive. And it shows more than anything in Brazil," he added.

Looking ahead, Friday will be a telling day as to what direction the market will take for the next month. Investors will look at non-farm payroll numbers for clues as to how the Fed will act.

"The volume has been much less than it has been for the last couple of days. I guess investors are waiting for tomorrow's [Friday's] numbers," added the sellside source.

Worries restrain primary

Interest rate woes are also holding back activity in the primary market, he noted.

"Everyone is waiting until there's a much more certain environment to come to the market. They wouldn't want to risk their cost of funding with all this volatility, he said.

Sovereigns such as Brazil and Turkey are expected to issue this month.

"They always issue in January," he said.

However, there was some action in the primary market Thursday.

Mexico's Axtel SA de CV priced a $75 million add-on to its 11% senior notes due Dec. 15, 2013 (B2/B) at 106.75, resulting in a 9.638% yield to worst.

Credit Suisse First Boston ran the books for the Rule 144A/Regulation S with registration rights add-on.

Mexico upgrade

Going against the overall negative trend was Mexico on a ratings upgrade.

In the late afternoon, Moody's Investors Service lifted Mexico's foreign currency ratings to Baa1 from Baa2, citing an "improvement in a number of external debt ratios and the presence of a strong international liquidity position," according to a statement.

"The market, for the most part has been soft except for a little lapse where you saw prices uptick on the back of an upgrade to Mexican credits," Alvarez said.

Bonds from Mexico tightened on news of the upgrade, said the sellside source. This also included Mexico's recent retap of its bonds due 2015.

On Tuesday, The United Mexican States re-opened its bonds due March 2015 (Baa2/BBB-) with an additional $1 billion via Citigroup and JP Morgan. The add-on was priced at 107.10 to yield 5.694% or a spread of Treasuries plus 145 basis points.

"They [the 2015s] have been widening since they came to the market because that day there was some news related with the Fed," said the sellside source.

On Tuesday, markets were spooked by the minutes from the Federal Reserve meeting, which sparked new concerns that rates would move higher.

"And all the market on Tuesday widened. But today [Thursday], there seems to be a rally in UMS bonds," remarked the sellside source.

Trading volume increased when the news of the upgrade hit, said Alvarez.

Mexico's index of the JP Morgan Global tightened three basis points to 180 basis points at the close of the session.

EM flows at $213.4 million

Despite all the inflation headaches this week, emerging market bond mutual funds did well. They saw strong inflows at $213.4 million for the week ending Jan. 5, according to EmergingPortfolio.com Fund Research.

Indonesia to tap market

As reported on Wednesday, the Republic of Indonesia is expected to offer up to $1 billion of global bonds by the end of the first quarter of 2005, amid recovery efforts underway for the victims of the Dec. 26 tsunami.

"There are always rumors that Indonesia is going to do a new deal," said a trader. "I think the likelihood that they print a new deal in the next 60 days is greater than 70%.

"Indonesia is the richest credit in Asian emerging markets," he said.

For instance, the Indonesia bond due 2014 is bid at 1001/2, noted the trader.

"That works out to be an asset-swap spread of 200. An asset swap for 10-year single-B of 200, compared to double-B Philippines, which is in the high 300s, shows you that Indonesia is very rich.

"It's technically rich because there are only two sovereign bonds out there: the 2006 and the 2014. And there are two Freeport bonds [a mining company with interests in Indonesia].

"Asian emerging markets investors want diversity outside of the Philippines. And there is not that much high-yield emerging markets debt out there other than the Philippines. And there is very little high yielding sovereign debt out there, other than the Philippines," he commented.

There are two Vietnam Brady bonds, one Pakistan bond, and some Indian paper, although it is not sovereign India paper, he added.

"In clamoring for diversification the market has bid the Indonesia 2014 up to the moon. It's way too rich. But it's not going anywhere because people are willing to pay for the diversification," he remarked.

Sri Lanka Telecom bonds fall

Paper for Sri Lanka Telecom has slid in recent sessions in the wake of the destructive tsunami, according to the trader.

Prior to the disaster, the Sri Lanka Telecom bonds due 2009 were bid at 100, 101 offered.

"After the disaster, they fell in price to 95 bid, 97 offered. No bonds traded there.

"Standard & Poor's came out almost immediately after the catastrophe and put them on outlook negative.

"If it hadn't been for that the bonds would probably not have fallen as much as they did. But S&P spooked the market a little bit. And I think the sentiment of the market reacted too hastily," noted the trader.

The bonds have since retraced some of their losses, said the trader.

"They are 98 bid, 100 offered, three points off the lows. The bid is still two dollar-points below where they were before the Christmas holiday," he remarked.

CNOOC, Korea First Bank down

The third-biggest oil and gas group Chinese National Offshore Oil Company (CNOOC) is considering a $13 billion bid for U.S rival Unocal, according to an afternoon story by the Financial Times.

"On that news spreads blew out by about 15 basis points," said the trader.

Meanwhile, HSBC may withdraw its bid for Korea First Bank, according to a market source. HSBC appears to be unwilling to beat Standard Chartered Bank's higher offer.

The Korea First bond due 2034 traded down one point to 111 bid.

Local currency interest

Finally, investors are turning to local currency-denominated debt to pick up yield in what looks to be a generally harsher year for interest rates.

"Investors are getting into local markets trades only because yields on external debt are so incredibly low," said an emerging market analyst.

"As spreads on external debt increase - which I expect will continue through the first half of the year - investors are going to have less and less reason to be crowded into local markets positions.

"That's not to say that we'll see currency crises in EM, only that the adjustment in some of the local markets (Chile, South Africa, Turkey, maybe Brazil) could be a little rough," he noted.

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