Economic concerns, balance sheet tightening thin liquidity; primary market remains hushed

By Christine Van Dusen

Atlanta, Sept. 30 - Emerging markets investors continued to sit on the sidelines on Friday as continued economic volatility - and a move by dealers to tighten up balance sheets at quarter's end - thinned liquidity and quieted the primary market.

The Markit iTraxx SovX index spread widened to 350 basis points from 340 bps as European equities sold off on Friday morning.

South Africa saw some two-way flow for the sovereign, while the rest of the sector was quiet. Russia was thin, with metals and mining seeing more pressure. And some small buying was reported for Lebanon's 2016s while small selling was seen for the sovereign's 2020s.

"Early concerns that the liquidation going on in Asian high yield would spill took a while to materialize as retail clients stepped in to buy all the high-quality favorites," a trader said.

Said a Connecticut-based trader, "The liquidity has definitely dried up considerably. The higher-yielding names that are a little more liquid are harder to move, so we're seeing sellers of Dominican Republic, Jamaica, Pakistan and some other names that don't trade regularly and are not on brokers' screens regularly."

Buyside accounts were looking for safer havens and liquid issues, he said.

"They're afraid of liquidity crunches," he said. "Dealers are tightening up their balance sheets and trying to salvage whatever profits and losses they are going to have in the final quarter."

He said that one big dealer, with a year-end on Oct. 31, was already reducing his balance sheet and was very reluctant to take on big positions at this point in the year.

"Others have their year-end in November and the rest in December, so the liquidity is already starting to get siphoned away from the marketplace," he said. "The economic backdrop and volatility are not helping."

Tunisia, Morocco in focus

Later in the trading session on Friday, Africa saw a few bids, with even Tunisia's 2012 and 2013 notes getting some attention from the Street.

"Morocco's 2017s pushed lower, although it still feels like there's some nibbling around on that bond," a trader said. "It's still an outperformer versus its peers."

But overall, most African names felt heavy, he said. "And the illiquidity is obviously very painful."

Looking at Kazakhstan, some activity was seen for KazMunaiGaz.

And very little trading was reported for Ukraine.

Peso paper under pressure

Overall, emerging markets assets have seen real-money selling over the last two weeks, the Connecticut-based trader said.

Peso-denominated paper from Argentina has come under particular pressure, especially peso discount bonds.

"Peso discounts are closing at the lows of the year," he said. "The implied rate in the offshore peso paper in Argentina is trading close to a currency rate of 4.75 versus an onshore rate of 4.20. That's the widest between them on peso paper since the bonds were issued in 2005. So there's considerable pressure on anything currency-oriented."

Venezuela holds up well

One name that was holding up particularly well on Friday was Venezuela.

"Venezuela would typically be down 10 to 15 points in a market of this nature, historically," the Connecticut trader said. "But there are still a considerable number of people who think there's going to be a regime change in 12 to 18 months and that Chavez is worsening."

But the trader cautioned against too much optimism on that front.

"As we've seen in the Arab world with the Arab Spring, it can definitely create a power vacuum," he said. "But it does look like his health situation is not improving at this point."

Deal flow dries up

The primary market was quiet on Friday.

"We've heard about deals and then we don't really see anything," a trader said. "Nothing of note has come across our screens in a while."

He was keeping his eye on the planned $1 billion in notes from Colombia-based Banco de Bogota, which is expected to come to the market in October via bookrunners Citigroup, HSBC and JPMorgan. Also of interest are the dollar sukuk notes planned by Abu Dhabi-based developer Tamweel PJSC and $1 billion notes from Dubai-based airline Emirates.

"Latin America, though, has seemed to have gone very quiet," he said.

America Movil notes widen

The last active deal from Latin America was the $2.75 billion two-tranche issue of notes from Mexico's America Movil SAB de CV that priced in August.

The Mexico City-based telecommunications company sold $2 billion of five-year notes with a 2 3/8% coupon at 99.188 to yield 2.549%, or 158 bps over Treasuries. The second tranche was a $750 million add-on to its 6 1/8% notes due 2040, which priced at 108.916 to yield 5.502%, a spread of 190 bps over Treasuries.

"That's widened pretty significantly," a trader said. "We're still seeing guys in that deal who are looking to exit, more than add. But there are two-way flows."

Week sees record outflows

In other news on Friday, emerging markets bond funds recorded outflows of $3.19 billion for the week ended Sept. 28, according to a report from data tracker EPFR Global.

That's a weekly record, said senior analyst Cameron Brandt.

During the previous week, the funds saw outflows of $691 million, with $463 million attributable to funds with local currency mandates.

"The recent spike in risk aversion seems to have caught up to this asset class," Brandt said. "I did hear that a Pimco bond manager reckons it was the result of fund managers readjusting to control risk. If that's true, I wonder why they waited until now."

Said the Connecticut trader, "The outflows have been particularly noticeable on the local market side. The local market side has been badly hurt by some of the moves in the currency markets. So we've seen some selling of real-denominated sovereigns and corporates as well as some local paper in Peru, Uruguay and Colombia."

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