Another losing session; Ecuador, Venezuela, Argentina lead drops; EM funds post $29 million inflows

By Paul Deckelman and Aaron Hochman-Zimmerman

New York, Aug. 16 - It was more of the same in emerging markets Thursday. Developing-country bonds were beaten down for a third consecutive session as investors worldwide, unnerved by an escalating credit crunch, pulled money out of perceived riskier investments like high yield bonds and emerging debt and, for much of the session until a late Wall Street rally, equities.

That caused emerging spreads versus U.S. Treasuries to widen out substantially, although the main spread-tightening gauge, the widely followed EMBI + index compiled by JP Morgan & Co., was quoted a little later in the day as having trimmed some of that egregious spread widening, in line with the late rally in equities.

Once again, the trail downward was being blazed by Latin America's trio of high-beta credits, Ecuador, Venezuela and Argentina. Also lower were Mexico's bonds.

Apart from Latin America's mostly lower credits, Asian issues were also seen lower, particularly the Philippine sovereigns and, among the corporates, South Korean computer-chip manufacturer MagnaChip Semiconductor Ltd.

Turkey's bonds were lower, in line with a sharp fall in that country's currency unit, the lira, and continuing political tensions revolving around the upcoming selection of a president by the country's legislature.

But even amid the general carnage, here and there were surprises, including the unexpected news that emerging market bond funds - unlike their junk bond counterparts and other types of debt-oriented funds - actually showed an inflow for the most recent week.

Dramatic spread-widening

With equities taking a pounding for most of the day Thursday after the biggest U.S. mortgage lender, Countrywide Financial Corp., announced that it had fully drawn down on its $11.5 billion credit line after short-term financing was curbed - seen by many in the market as an act of desperation - U.S. Treasuries continued their "flight to safety" attraction, with the benchmark 10-year issue's yield falling 6 basis points to 4.66%, the lowest it has been since March.

That helped to blow out the EMBI+ index's measure of EM yields versus Treasuries by as much as 29 basis points at one point in the session, to 251 bps, the widest that measure of investor risk tolerance or aversion had been since the fall of 2005. However, it was quoted a little later in the day as having trimmed some of the earlier spread widening, in line with the late rally in equities, finishing around 20 bps over Treasuries weaker, at 243 bps - still the widest its been since the end of 2005.

Ecuador leads downside

The volatile, risky high-beta names of Latin America were again the biggest losers, with none bigger than Ecuador, whose bonds fell against the backdrop of the general emerging markets retreat and yet another manifestation of investor unease over the actions of populist president Rafael Correa, whose election last November has been roiling the debt markets ever since.

The spread over Treasuries on Ecuador's bonds at one point during the session surged to 790 bps, a 94-bps widening, although those losses were pared later on in the day and the bonds finished with a 75 bps widening to around the 7.70% mark .

Investors warily greeted the news that the Ecuadorian Congress, controlled by Correa loyalists, had voted to seat Miguel Ruiz, also an ally of the president, on the board of Ecuador's central bank. That is seen as the latest salvo in Correa's ongoing battle to bring the central bank more in line with his government's thinking, a development that would be greeted with dismay by the financial community, which supports the principle of central bank independence from the government.

Argentina, Venezuela continue fall

Argentina's bonds, recently hurt by persistent market angst over government corruption allegations - a top minister was forced to quit after a mysterious bag of money surfaced in the official's private office bathroom - as well as skepticism about the inflation numbers coming out of the government's statistics bureau, were again on the slide Thursday.

Its 8.28% benchmark dollar-denominated bonds due 2033were quoted as having fallen 3½ points to 77, a new record low for the issue.

Similar weakness was seen in Venezuelan bonds, with that country's spread over Treasuries expanding by another nearly 50 bps to 469 bps. The cost of insuring its bonds against a possible default via credit default swaps contracts rose 55 bps to a record 510 bps. As was the case with Ecuador, investors were seen worried about the possibility that the independence of the country's central bank might be compromised if reforms put forward by president Hugo Chavez are enacted. The unpredictable strongman also proposed amending the constitution to allow the president - in this case, himself - to serve as many terms in office as he can be elected to, rather than have to leave because of term limits.

Elsewhere in the Latin sphere, Mexico's peso-denominated bonds due 2015 were seen having widened out 16 bps to finish at 8.10%. Average Mexican bond spreads versus Treasuries widened to 327 bps, versus 318 bps the previous session.

Turkish debt widens

Holders of Turkey's bonds saw its dollar-denominated sovereign bonds widen out to 249 bps over Treasuries, according to the EMBI+, a 22 bps increase on the session. Its local bonds were also up sharply, yield-wise, hurt by a pullback in the lira currency.

Turkish bonds are also being weakened by uncertainty over what the presidential candidacy of foreign minister Abdullah Gul might mean, since the choice of the ruling AK Party is seen in some quarters as an Islamist. Turkey's staunchly secular military warned earlier in the year this it might have to step in to defend the secular state's nature, should Gul be selected as President by the parliament.

Philippines, MagnaChip bonds off

In trading earlier in the day during the Asian trading session, Philippine sovereign bonds were seen off 1½ points, with the benchmark 2031 bonds dipping to 106.5 bid, while the 2032s retreated to 94.75. The cost of hedging against a default in those bonds using CDS contracts widened nearly 20 bps to 210/215 bps.

A trader saw MagnaChip's bonds lower, its 8% notes due 2014 falling to 59 bid, 61 offered from prior levels at 64 bid, 66 offered, its 6 7/8% notes due 2011 at 77 bid, 79 offered, down 2 points on the session, and its floating-rate notes due 2011 also 2 points lower, at 81 bid, 83 offered.

EM bond funds show surprise inflow

With the market carnage of the past several days, one might think that money would have flowed out of emerging market bond funds - but one would be wrong. According to the latest statistics from Emerging Portfolio Fund Research, emerging bond funds saw net inflows of some $29.17 million in the week ended Wednesday - a statistic which EPFR managing director Brad Durham termed "surprising."

Equally surprising, Durham said was the fact that funds dealing exclusively in local-currency bonds, like Brazil's real or the Philippine, Columbian or Mexican peso, showed inflows of $62.5 million, versus some $62 million of outflows for funds holding "hard" currency bonds denominated in dollars.

"It's kind of odd," he noted. "I would think that with the dollar seriously strengthening against all major currencies, and minor currencies, and emerging market currency funds, that there would be more flows from the local-currency funds. But maybe there was enough flow activity in the first part of the week [last Thursday and Friday], to overcome the outflows in the last couple of days."

All told, Durham said, the more than 400 funds tracked by EPFR were down some 1.36% on the week, performance-wise.

Durham noted that U.S. bonds funds, high yield funds and global bond funds all showed big outflows, while the EM bond funds managed to eke out their gain.

Bono del Sur in primary

The primary market only has Venezuela and Argentina's Bono del Sur for local investors while the rest of the primary world bides its time until conditions are fertile enough for more new issues.

The third tranche of the Bono del Sur worth $1.5 billion will be auctioned as a three-bond package at 104%, according to the Venezuelan Ministry of Finance website. Orders are due by Friday.

The first two tranches of the bond were over subscribed when they priced $1 billion and $1.5 billion last November and March respectively, a market source said.

The results of the auction will be announced on Aug. 21, the source added.

Any level of success for the Bono del Sur would not factor greatly into people's view of the failing health of the larger emerging markets, a market source said.

The source added that even if the deal were widely available it would likely not generate interest outside the local market, in part because of the moves of Venezuelan president Hugo Chavez.

Risk aversion and hedge fund redemptions weigh on the minds of investors as Wednesday marked 45 days after the end of the second quarter.

"The markets appear a little rough today," said an emerging markets syndicate desk official who specializes in emerging Europe and the Middle East.

"Concern over commercial paper appears to be rearing its head," the syndicate official said.

Another market source conceded that volatility was as present in the market as ever, but suggested taking on risk in certain Asian corporates such as the Chaoda Modern Agriculture, Ltd. bonds due 2010, and debt from Philippine Long Distance Telephone, Inc. and Hynix Semiconductor, Inc. both due in 2017.

The source advised against adding risk in both Europe and Latin America as liquidity in both markets continues to drop off.

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