Post-Fed Friday sees good follow through after Thursday's short covering; Mexico firms ahead of elections

By Paul A. Harris

St. Louis, June 30 - Patriotic sentiments in the U.S. and beyond conspired to set a quiet tone for the Friday session.

In the States sources were priming for a long Fourth of July weekend.

Latin American players, meanwhile, were tuned into the World Cup soccer showdown pitting Argentina against Germany.

Elsewhere, heading into the weekend elections, Mexican debt rallied with the rest of the market as sources seemed braced for either of the leading candidates to prevail.

And the primary market maintained its repose on Friday. However sources say it will build, likely beginning during the week of July 10.

Enrique Alvarez, Latin America debt strategist at think tank IDEAglobal, told Prospect News on Friday morning that the broad market came higher from London.

"The mornings have been keying off of what Turkey does," Alvarez commented.

"And after repetitive interventions by the central bank Turkey has stabilized somewhat. The bond prices of Turkey are at least trading sideways now.

"So there is not a negative effect coming over from Eastern Europe into the New York hours."

Post-Fed follow through

Alvarez and other sources said that emerging markets began trading higher on Thursday following what was perceived as a market-friendly statement regarding inflation and interest rates on the part of the U.S. Federal Reserve's policy-making Federal Open Market Committee as it jacked up the short-term federal funds target rate another 25 basis points to 5.25%.

A trader who focuses on Latin names said that following the Fed action the market had tightened about 20 basis points in a lot of Latin American product, and added that the Friday session saw the market maintain its "better tone."

The source spotted one of the asset class's leading benchmarks, Brazil's dollar-denominated 11% bonds maturing in August 2040, better by 5/8 on the session at 124.10 bid, 124.30 offered.

Meanwhile at the nearer end of the maturity curve, Brazil's dollar-denominated 8% amortizing bonds maturing in 2018 were 90-cents better at 105.75 bid, 105.85 offered.

IDEAglobal's Alvarez noted that some market watchers had been bracing for a possible 50 basis points move on the part of the Fed

"We didn't buy the story," he said. "The impact would have killed the economy, I think.

"The Fed tried to restore some credibility on Thursday," Alvarez added. "They left open more possibilities than they previously had.

"Whereas they had been very strong on inflation in a rhetorical sense, on Thursday they also recognized that there is a softening in the economy, as far as growth is concerned.

"Essentially they left both sides of that equation open for August. They could go higher or they could stop.

"I think the market has admitted that this is the road to go.

"Also the market likes to think in terms of a pause coming up, which is why it rallied Thursday."

A whiff of real money

Meanwhile a trader who focuses on Asian fixed-income securities said that the market had a solid tone during the Friday session.

"There was a good rally in just about everything, on Thursday," the source said.

"Initially it was very much short-covering led: the outperformers were the hedging vehicles - the CDS indexes, the single-name CDSs.

"But it seems to have gotten some legs."

The trader specified that it was still too early to tell whether the post-Fed strength would result in more "real-money" buying, and added that this riddle would not be solved until after the long July 4 weekend in the United States had run its course.

The source noted strength across the credit curve in emerging markets, adding that on Thursday the higher beta issues were outperforming.

"Argentina was better. Brazil was better. Philippines was better. Japanese bank capital was better," the source said.

"Those were some of the sectors that had performed worst on the way down."

The source spotted the Philippines dollar-denominated 10 5/8% bonds maturing in March 2025 at 124 bid, 124.375 offered at their Friday closes.

And Indonesia's dollar-denominated 8½% bonds maturing in October 2035 were at 107.375 bid, 107.875 offered.

Both were unchanged to slightly better on the session, the trader said.

Liquidity: a fly in the ointment

The trader also said that technicals in emerging markets are pretty solid at the moment, but added that "liquidity" is presently "the fly in the ointment."

On Thursday, fund-watcher EmergingPortfolio.com reported a $363.0 million outflow from dedicated emerging markets bond funds for the week to June 28, the seventh consecutive weekly drain from those funds.

It trails the previous week's $321.7 million outflow, leaving the year-to-date net flows just shy of $3 billion in the black, representing an 8.71% increase in assets under management for 2006.

Regarding the string of outflows, the trader who focuses on Asian fixed-income securities said that as long as there is some concern on the part of "real-money investors" that they might be facing redemptions, which could serve to put a cap on things.

The trader said that trailing the recent market volatility real money accounts are likely quite long cash at present - a natural defensive reaction in the face of the outflows.

"The initial portion of the strength we have seen, post-Fed, has been short covering," the trader said.

"A lot of it is the Street taking hedges off, and a lot of the fast money - especially the hedge funds - taking defensive trades off."

The Mexican elections

On the political front, emerging markets investors were awaiting the outcome of the weekend's presidential elections in Mexico, pitting Andres Lopez Obrador of the Democratic Revolution Party against Felipe Calderon of the National Action Party.

A sell-side source said that during the market's recent sell-off Mexican debt may have traded off a bit more than the rest of the market, but was not seen as dramatically underperforming the market.

"People saw the volatility surrounding the elections as possibly impacting their positions, and were wondering if they should hold onto the stuff," the sell-sider said.

IDEAglobal's Alvarez said, however, that the sell-off in Mexican assets seen during the mid-to-late June volatility in emerging markets needed to be taken in the context of "a very large move higher in U.S. Treasuries," which put pressure on Mexican debt.

"There was the side effect of close election polls which impacted debt prices and the peso," he added.

"However this week we've seen a solid performance on the part of Mexico, due to the fact that Treasuries have acquired a yield peak, and have traded back following Thursday's Fed news."

Alvarez drew a comparison between the Mexican elections and those which took place in Peru in early June, resulting in the moderate Alan Garcia defeating the left-of-center candidate Ollanta Humala.

"The fear of Mexico's left-of-center candidate winning has transformed into more of a hope-sentiment that things will be less negative than previously speculated, and that going forward the transition will be smooth and that overall things won't change that much," Alvarez commented.

He added that during the past two days Mexican debt prices have actually strengthened in conjunction with "a very good run-up in the Mexican peso, which is now about 11.26."

Alvarez added that the real hazard, with regard to the Mexican elections, is a contest that results in no clear winner.

"If the election has to be called by the Electoral Tribunal, you could see a situation of conflict and unrest which could bring about a reaction with regard to risk-taking on the sovereign side," he said.

"In that situation you could see prices come off somewhat.

"But the bottom line is that you are talking about an investment-grade credit. Unless things get really get out of hand the downside is limited, I think."

Friday morning the strategist spotted Mexican long-dated benchmark paper at 115 bid, 116.75 offered, up two points on the day, and up from 111.81 bid at the June 23 close, seven days previous.

He noted that the front end of the Mexico maturity curve has moved much less, actually underperforming because the front end of the Treasury curve has outperformed.

"Maybe the front end has caught more of the doubts regarding the election than is the case with the long end," he said.

Later Friday a trader spotted long-dated Mexican paper closing 115.75 bid, 116.25 offered, up 90-cents.

Election rumor mill

In a Friday email message a market source suggested that at least one tidbit from the election rumor mill may have given Mexican paper a boost.

The source said that Lopez Obrador is reportedly considering appointing economist Javier Beristain as minister of finance.

The source added that Beristain, who is the currently director of private pension fund, and served in a financial post in the Mexican government in the 1990s, is perceived as potentially more market riendly than Rogelio Ramirez de la O, Obrador's current chief economic advisor who is also seen as a contender for the role of finance minister.

In the event of a victory by the left-of-center Obrador,Beristain's appointment, should it materialize, could help to buffer any negative market reaction, the source asserted.

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