Emerging market spreads wider; China tightens price talk

By Reshmi Basu and Paul A. Harris

New York, Oct. 20 - Spreads for emerging market debt continued to widen Wednesday as a result of a short-term market correction.

"There's no tone in the market," said a trader. "Things have just been soft this last week."

Brazilian paper continued to feel pressure from Tuesday's rumors that the government was putting pressure on the central bank to hold the Selic rate at 16.25%. And another rumor buzzing around was that central bank president Henrique Meirelles had resigned.

The Central Bank previously denied the allegations about the pressure to hold rates steady and there was no announcement to support the Meirelles speculation.

After market close, the central bank raised the interbank rate to 16.75%. The market expected the rate to be increased to 16.50%.

During Wednesday's session, Brazil's debt was down during the day but bounced back. The Brazil C bond was up 0.062 to 98.687 bid at the close while the bond due 2040 added 0.10 on the session to 111½ bid.

Meanwhile, there were other winners and losers during Wednesday's session.

Mexico's bond due 2008 gained a quarter of a point to 114.60 bid. The Russia bond due 2030 was bid at 99 1/8, up 1/4.

Losers included Turkey and Venezuela. The Turkey bond due 2034 lost ¾ point to 1373/4. And the Venezuela bond due 2027 dropped 0.20 to 101.30 bid.

Overall, the JP Morgan EMBI+ rose 0.08%. Its spread to Treasuries widened four basis points to 423 basis points.

Drivers in the market

Emerging market debt and U.S. Treasuries have been following divergent paths in recent sessions. Spreads have widened as yields on U.S. Treasuries have dropped. The yield on the 10-year Treasury notes fell to 3.98% during Wednesday's session.

"Oil prices are good for some EM countries, bad for others. So I don't think that is a key driver in the market," said a buyside source.

And while the U.S presidential election has some risk, the equity market does not seem to be feeling its impact one way or another, he said.

"I think the Fed to some degree worries this market."

However, the market has held up quite nicely, in spite of recent tightenings by the Federal Reserve, according to the buyside source.

"I think it's more that valuations are not wonderful and that makes it tougher for the market to rally.

"If the market can't rally, I would doubt that it would just go sideways - too much speculation in the market for it to go sideways."

Market correction, says investor

The buyside source described Wednesday's market action as "soft, very soft"- a follow-through from Tuesday's trading.

"We opened up yesterday [Tuesday] and we were 410 over on the EMBI," said the buyside source.

"It closed last night at 419 and we are at 423 today [Wednesday] - quite a large move from yesterday morning [Tuesday].

"The high beta stuff definitely seems to be trading off more," he said.

And the softness of the market has to do more with a general market correction rather than being driven by any headlines, according to the buyside source.

Just by looking at the EMBI chart, one can tell that "we have just gone so far, so fast," he noted.

"We have rallied over 100 basis points since the end of May, about 50 since year end. Over the last two years, it's been straight down.

In May, concerns over Fed tightening unleashed a vicious market correction.

Now, once again, the market is at all time tights, he said.

"There is definitely a bias towards spread widening in this environment."

Furthermore, the buyside source expects to see a real market correction in the short-term.

"Unless you get a broader correction in the equity market, the U.S. high yield market, relative value in the emerging market still looks attractive and absolute value still looks very poor," he noted.

And there could a stronger market correction if the Fed acts more aggressively than current expectations, he said.

In terms of his portfolio, the buyside source is overweight in Russia.

"I'm reducing the size of my overweight in Brazil.

The buyside source said he finds issuances from Kazakhstan attractive, including Intergas Central's planned offering of $200 million seven- to 10-year bonds (Baa3/BB) via ABN Amro and JP Morgan.

"Kazakhstan is really Russia on steroids. So Russia grows 5%, they grow 10%.

"You take everything out of Russia and double it - and that's Kazakhstan. [Vladimir] Putin is becoming a dictator, they already had a dictator.

"It's very similar, but much more leveraged to oil and growth than Russia. And Russia is very leveraged to oil and growth."

As for countries like Colombia and Peru, he "likes the fundamentals but the valuations spook" him.

He is "looking to do more of a credit upgrade trade in general."

Looking ahead, the investor is taking his cue from the U.S. dollar and inflationary pressures.

"Weaker dollar and higher inflation is definitely good for emerging markets to the extent that it doesn't make the Fed tighten too tightly and tighten up liquidity conditions.

"That's the key: do we get an orderly sell off in the dollar and steady higher inflation or is it much more of a shock to the system?

"That worries me more than anything, but I think the timing is right for a correction here," he commented.

China tightens price talk

The People's Republic of China tightened price guidance for its upcoming €1 billion offering of bonds due 2014 to yield mid-swaps plus 40 to 41 basis points.

Initial price guidance had been set at 43 basis points more than euro mid-swaps.

A market source said the books were oversubscribed.

Guidance for the other tranche, $500 million bonds due 2009, has been set at 63 basis points over U.S. Treasuries.

BNP Paribas, Deutsche Bank and UBS AG are running the euro tranche and Goldman Sachs & Co., JP Morgan, Merrill Lynch & Co. and Morgan Stanley are managing the dollar tranche.

Pricing for the dual tranche Regulation S deal is expected on Thursday.

Out of Europe, the Republic of Hungary set initial price guidance for its €1 billion seven-year benchmark (A/A-/A-) in the area of mid-swaps plus 12 basis points.

Dresdner Kleinwort Wasserstein and JP Morgan are running the deal.

From Latin America, Corporacion del Cobre de Chile (Codelco) set price guidance for its $500 million 10-year senior unsecured notes (A2/A) at U.S. Treasuries plus 90 basis points via Citigroup and HSBC.

"Too tight for me," said another investor.

The company, based in Santiago, is the world's biggest copper producer.

Argentina's Pan American Energy set guidance for its $160 million five-year notes (B1/B/B+) at 7¼% to 7 3/8% via Deutsche Bank

The books closed at 2 p.m. ET Wednesday and official allocations will be confirmed on Thursday.

"The pipeline actually seems a little quiet," said the buyside source.

"With China and Hungary getting out of the way, those are the mega deals and those are investment grade.

"As far as the higher yielding names, it seems kind of quiet."

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