Emerging market debt refocuses on Fed; Brazil's Celpha/Cemat talks $100 million bonds at 8½% area

By Reshmi Basu and Paul A. Harris

New York, Feb. 1 - Emerging market debt remained skittish Wednesday as investors refocused their attention on whether or not the Federal Reserve will alter its monetary tightening campaign.

During the session, the Brazilian bond due 2040 gained 0.10 to 129.20 bid, 129¼ offered. The Mexican bond due 2026 lost one point to 160 bid, 163 offered. And the Russian bond due 2030 shed a quarter point to 111½ bid, 111¾ offered.

In the primary market, Brazilian utilities Centrais Electricas Matogrossenses SA (Cemat) and Centrais Eletricas do Para SA (Celpa) set price guidance for a $100 million bond offering at a yield in the 8½% area.

Each plan to sell $50 million of six-year unsecured senior notes (/B-/), which will not be traded separately.

Unibanco Securities and Merrill Lynch are leading the Rule 144A/Regulation S transaction.

Meanwhile pipeline deals have become a scarce commodity of late. Indeed, one source remarked that everyone expected a deluge of new deals and instead emerging markets are seeing a trickle.

The lack of new deals has even spurred some market participants to spread rumors, according to a trader who focuses on high-yielding Asian credits. He said that hedge funds that have been short the Indonesia bond due 2035 were spreading rumors of a forthcoming sovereign deal.

"That's a new form of idea generation: if you don't have a good idea to get long something, spread rumors on your shorts and try to buy them back.

"Guys who are short are getting creamed and are doing anything that they can to cover," he said.

Growing popularity of peso deals

But while the external market's pipeline has cooled down, it looks as if everyone wants to get a piece of the Mexican peso debt market, which one emerging market analyst described as "weird."

Even the Province of Quebec issued some Mexican peso debt last week, he noted.

Also tapping last week, Inter-American Development Bank sold two tranches of peso debt, which included Ps. 118 million of 7.65% bonds due 2011 and Ps. 2.5 billion of 8% notes due 2016.

On Tuesday, Prospect News reported that several corporates would be issuing eurobonds denominated in Mexican pesos in February. Potential issuers include Nordik Bank, Morgan Stanley, UBS Investment Bank, JP Morgan and the World Bank.

"Part of it is simple risk diversification, as the MXN-denominated debt grows more liquid, it becomes a more viable place to issue, which invites issuers looking for currency diversification," said the analyst, adding that there was a speculative element in the peso issuance.

"For those issuers whose revenues are mostly hard currency (Morgan Stanley, Quebec, etc.), issuing an MXN-denominated liability will make sense if the peso sells off relative to the dollar. And at current peso interest rates, it would not take much peso depreciation for that trade to pay off," he concluded.

Emerging debt still seen appealing

Emerging market debt has come under pressure this week. But "no way" has the asset class lost its shine, according to a debt strategist.

"I think there is a lot of enthusiasm for local currencies in emerging markets and I think there is a fair amount of skepticism about emerging market dollar-pay traditional EM spreads because they are about 200 [basis points] over," he noted.

Of course, the market may enter a period of spread widening, but the strategist also points out that most of the macro-forecasts are "pretty friendly.

"It's pretty goldilocks out there if you talk to most people."

Meanwhile, the strategist added that even though Brazil's recent eurobond issue met with less than stellar demand, it is not a sign that the market is showing cracks. Brazilian euro-deals never do well, given that it is a new territory for them, said the strategist, adding there needs to be some type of market development for those endeavors to be successful.

On Monday, Brazil reopened its 7 3/8% bonds due February 2015 (Ba3/BB-/BB-) to add €300 million in a drive-by. The deal was downsized from €500 million.

Asian bonds are well-bid

Asian trading was stable Wednesday, according to a market source, who added that the market was not pinched by the Fed's decision the day before to raise interest rates.

Asian bonds are very well bid and are seeing very deep institutional interest, according to the trader. He added that high-beta bonds are hard to offer and that people are really looking for offers.

"It just keeps grinding tighter and tighter. The offer, one minute, is the bid on the next trade."

The trader said that it is a sign of a "short Street," as well as an investor base that is not nearly as risk-averse as the Street thought a couple of weeks ago.

"The way the market took Google today [Wednesday] and the way that high-yield prices, whether in Asia or Latin America, responded to the down-trade in [U.S.] Treasuries is a very solid endorsement, at least of the technical value of the [emerging markets] asset class.

"It doesn't say anything about fundamentals, which I think a lot of people agree are stretched. But no one who wants to keep their job is willing to be short the market right now"

Seamless transition at Fed?

Wednesday marked the start of a new era at the Federal Reserve. Ben Bernanke, a former White House economic adviser and Princeton professor, will take over as the new Fed chief thus ending the 18½ year rule of Alan Greenspan as the inflation warrior.

The market does not seem to be too worried about the transition, noted the strategist.

"We have no particular bias. Our thought is that Bernanke is superbly qualified and he will be very collegial," he said.

However, Bernanke's transition will not be as seamless as the market anticipates, according to Jephraim P. Gundzik, president of Condor Advisers, Inc, which provides comprehensive emerging markets investment risk analysis to individuals and institutions worldwide.

He said that Bernanke will feel some pressure to loosen the grip on monetary policy so as to not restrict economic growth at least in the first half of this year. And some of that pressure will come from president George Bush.

"I don't think he is going to have much choice once the economy begins to reaccelerate, which it will inevitably. They are going to have to start raising interest rates as inflation is going to be going up more quickly than anyone anticipates.

"I think basically this is going to be a much more politicized Fed than certainly the Greenspan era," predicted Gundzik.

Furthermore the strategist noted that there is one big unknown. Alan Greenspan was heralded as brilliant crisis manager. It is unknown how Bernanke will handle an economic crisis such as the Asian financial meltdown.

For instance, Gundzik noted that whenever there was a potential economic downturn, Greenspan would flood liquidity into the market, which would bail out higher risk investors. This so-called "Greenspan put" occurred in 1997. For instance, he helped rescue those unlucky investors who poured money into Russian bonds by essentially setting interest rates to near 0%.

"I don't think the new Fed is going to be fundamentally different from that," he noted.

Additionally, the Fed will be focused on ensuring that the housing market does not fizzle, remarked Gundzik.

"I definitely think we are heading for higher inflation and that is going to make the Fed to take very strong action in the second half of this year," Gundzik noted.

Nonetheless, no one seems to know where the next market shock will come from as well as what challenges lie ahead for the new Fed, observed the strategist quoted above.

"At the moment, the consensus forecast for the U.S. economy looks pretty good. Looks like Europe is speeding up, Japan is speeding up," noted the strategist, emphasizing that growth is good for emerging markets given the equity dimension.

"At the moment, people are still feeling like most of the themes that have worked: commodity price strength, decent growth story, low inflation and just important low inflation growth story are still intact. So in that world, it's hard to get too pessimistic about EM debt prospects," he said,

"The one thing is that we are really priced to a no-shock scenario.

"200 [bps over Treasuries] is not giving us a lot of room," he said, adding that the next shock would be bearish. But it is anyone's guess where that surprise will come from, he added. And mostly likely, it won't be from Bernanke.

One more Fed hike?

Most market participants are in agreement that the Fed will hike rates one more time at its March meeting and then pause. Gundzik also falls in that camp. Additionally, he said he does not expect to see more tightening, not until oil hits $100 per barrel, which he warns is not too far in the future.

Meanwhile the showdown over Iran's nuclear program has resulted in jittery oil prices.

"The risk is definitely increasing that there will be a unilateral U.S. strike or Israeli strike against Iran.

"And that is one of the factors that is pushing oil right now. There's not a consensus in the Security Council, even though it appears after yesterday's [Tuesday] events that China and Russia have come aboard on America's views on Iran."

Nonetheless, Gundzik said those two countries will not support sanctions against Iran because of their geopolitical and commercial ties to the nation.

"In essence, it's going to back the U.S. in the corner," he said, adding that the United States is losing its influence. The Hamas win in last week's Palestinian parliamentary elections was a blow to U.S. foreign policy in the region, which is upping pressure on the Bush administration to re-establish its influence.

Nonetheless one source told Prospect News that the Iranian showdown has had little impact on bonds within the asset class overall.

"I think there is a different class of investors in emerging markets now. Over the last couple of years, the asset class has traded along the lines of the U.S. market or European markets, so it seems like it's not an emerging market anymore. It's becoming more mainstream and I think there's a dearth of realistic analysis," he told Prospect News.

Gundzik warns investors that oil prices may be the one trigger that brings down all the markets in the next six months.

He still recommends that investors remain vested in oil producers such as Mexico, Russia and Venezuela for the first four to six months of this year.

But Gundzik cautions that investors will need to re-examine the oil-producer story in the second half of this year on the likely scenario that the U.S. economy will begin to grind down to 2% growth, which will cause a dramatic reduction in global demand for oil. That rebalance of supply and demand will result in lower oil prices.

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