Emerging market debt loses ground; Malaysia International Shipping prices upsized $1.1 billion

By Reshmi Basu and Paul A. Harris

New York, June 25 - Emerging market debt traded lower as investors' uneasiness over interest rates magnified ahead of the Federal Reserve Federal Open Market Committee meeting.

"The FOMC meeting has a lot of people treading water," said a market source. "Some people seem oblivious to what may come out of that meeting while other people seem nervous.

"Wednesday afternoon should be interesting," added the source. The Fed is due to announce its decision at 2:15 p.m. ET on Wednesday.

In trading Friday the JP Morgan EMBI Global Index was down 0.58%. Its spread to Treasuries widened eight basis points to 480 basis points.

Brazil, Ecuador and Russia were all down. All three countries' spreads widened by double digits.

The Brazil bond due 2040 was down 1.30 to 92¼ bid while the C bond was down a point to 90½ bid.

However, Argentina was the biggest loser of the day. Its component of the EMBI Index fell 1.92%. Its spread to Treasuries tightened by three basis points to 4977 basis points. And the Argentine bond due 2008 fell half a point to 27 bid.

Meanwhile in primary action, three corporates came to market ahead of the impending interest rate hike.

Malaysia International Shipping Corp. priced an upsized $1.1 billion offering of senior unsecured notes (Baa1/BBB+). The deal, increased from $1 billion, was comprised of $400 million of five-year notes and $700 million of 10-year notes.

"I didn't look closely at it because it was too tight of a deal for me," said Steve M. Hope, managing partner of Outrider Management.

The five-year notes priced to yield Treasuries plus 120 basis points, tighter than the 125 to 135 basis points guidance.

The 10-year notes priced to yield Treasuries plus 155 basis points, within guidance of 150 to 165 basis points.

Barclays Capital and Citigroup ran the books for the Rule 144A/Regulation S bond offering.

From Brazil, Banco Itau Europa SA priced €200 million of three-year floating-rate notes (Baa1/BBB+) at 99.41. The coupon will float at three-month Euribor plus 45 basis points. The yield is three-month Euribor plus 47 basis points.

HVB, ING and BIE Bank & Trust ran the books.

Poland's TPSA Eurofinance France SA priced €300 million of 4 5/8% notes at 99.416 to yield mid-swaps plus 66 basis points via BNP Paribas and Deutsche Bank Securities.

The issuer is a financing subsidiary of Telekomunikacja Polska SA.

Stay short, suggests Outrider's Hope

Outrider's Hope has moved to a relatively short duration in face of rising U.S. rising interest rates during what he expects will be a sluggish summer for the market.

However he has held on to his Brazil 2040s, a strategy he says is "more as a portfolio hedge than anything else."

He has reduced his exposure in Mexico because of the "phenomenon associated with rising markets.

"I happen to have most of my investments that seem heavily correlated with the general level of emerging market debt in Mexico," Hope said.

"I've been both selling off some longs [in Mexico], and increasing the size of my shorts [in Latin America] over the last week and a half."

Wednesday will be a crucial day for the markets as two anticipated events unfold: the Federal Open Market Committee meeting and the rickety handover of power to Baghdad.

"There's not that much reason to expect a market rally no matter what they [Fed officials] do," said Hope.

He added: "I think the actual impact of less liquidity in the system over the next few weeks will make people nervous.

"And also with the handover of Iraq on June 30, the headline risk is there, even though I tend to think that is really not likely to have a long-term impact on security prices.

"The amount of bloodshed we see in the next two week or two months should not necessarily have an impact on Brazilian debt prices or even Turkish debt prices. It just doesn't impact it that much," he added.

And it is unlikely that emerging markets will see a summer rally.

"The only reason that it might happen is because of inflows into the space - nothing fundamental that would make people feel positive," said Hope.

"I think it will be unlikely that we would have a big summer sell-off because there should be reasonable inflows.

"It would take something really dramatic for the Fed to move faster than they are.

"And it doesn't matter how good the economic numbers are unless inflation sustains its current pace," noted Hope.

Meanwhile, one portfolio manager is keeping her holdings.

"I'm just holding the stuff that I have," said Diane Keefe, Pax World High Yield portfolio manager.

"The market took a whack a few weeks ago at the same time high yield took its whack but now it seems to be recovering.

"The Brazil 101/4s due 2013, which I watch, are up around 96.75. They were down around 87 at the bottom.

Keefe owns Brasil Telecom and regional fixed-line phone company Tele Norte Leste Participacoes SA.

"Both of those are investment-grade rated because of the political risk insurance. So they have been trading through the sovereign yield."

Emerging market outflows

There have been eight consecutive weeks of emerging market outflow, according to EmergingPortfoliio.com Fund Research.

Emerging market bond outflows were $114.9 million in the week ending June 23 or 0.72% of total assets.

Since the first week of May, outflows have amounted to $1.05 billion.

"One of the dealers I talked to said that it's basically not the core emerging markets players doing the selling, it's investment grade and high yield people, dabbling a little, who, when they get nervous about the market at all, sell their emerging markets exposure," said Keefe.

"My feeling is that if you liked the credit when you bought it and it gets cheaper, you don't sell it then."

Keefe, whose Pax World High Yield Fund submits the credits in which it invests to a series of social issues-screens, is still maintaining a cautious outlook on the U.S. economy.

"It's wobbling between inflation and deflation."

Keefe told Prospect News that she anticipates a 25 basis points increase in short term interest rates at this coming Wednesday afternoon's FOMC meeting.

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