Emerging market debt sees wider spreads; Peru's Kuczynski named prime minister

By Reshmi Basu and Paul A. Harris

New York, Aug. 16 - Spreads for emerging market debt widened in thin volume as the asset class decoupled itself from the rally in U.S. Treasuries Tuesday.

The market ended the day at the lows of the session, according to one market source.

A tamer than expected U.S. Consumer Price Index coupled with a softer U.S. industrial production report triggered gains in the Treasury market. By the close of trading, the yield on the 10-year note stood at 4.21%, down from 4.29% at Monday's close, putting it at its lowest level in three weeks.

Nonetheless, despite the Treasuries upswing, emerging market debt underperformed on a spread basis as investor nervousness shook Brazilian financial markets. The JP Morgan EMBI+ Index gained 0.11% while spreads widened by four basis points to 288 basis points over Treasuries.

"The political noise component comes and go," said Enrique Alvarez, Latin America debt strategist for think thank IDEAglobal.

Also another reason as to why emerging market debt may have underperformed Treasuries is the market belief that Treasuries are overextended, he noted.

Jitters on Brazilian corruption scandal

On Tuesday, thousands of supporters held a street demonstration for president Luiz Inacio Lula da Silva. But investors are worried that Lula will be somehow implicated in the congressional probe of government corruption.

"In light of that on and off noise, you have a very unstable Brazilian market, evidenced by the drop in the Bovespa and the slight erosion in the currency," remarked Alvarez.

And that has been chipping away at Brazilian credits, said sources.

"The story has more legs than I thought," said a buyside source.

"But I don't think it's necessarily going to change the outcome of the election," he said.

The real impact will be felt if there is a smoking gun implicating Lula.

"I think losing [former chief of staff Jose] Dirceu was a blow because he was a capable guy but not the end of the world."

So far, Dirceu has been the only major casualty stemming from the probe. He is currently serving as a federal deputy. Four ruling party leaders have also resigned.

Meanwhile, the buyside source said higher Treasuries did generally yank up sovereign debt prices.

During the session, the Brazil bond due 2040 was an exception to that trend, going home at 118.45 bid, 118.55 offered, down 0.20.

The Russia bond due 2030 added half a point to 112.80 bid, 112½ offered. The Mexico bond due 2034 was at 106.40 bid, 106.90 offered, adding 0.65. The Venezuela bond due 2027 was at 106.70 bid, 106.95 offered, gaining 0.30.

Ecuador and Venezuela

Ecuador's newly named economy minister Magdalena Barreiro traveled to Caracas where she is expected to facilitate the direct placement of $300 million in five-year Treasury notes to the Venezuelan government. The funding has become a necessity, given that the World Bank will not give Ecuador the $100 million from a previously committed structural adjustment loan. But the relationship may jeopardize Ecuador's ability to negotiate with multilaterals.

"It's definitely an important relationship for Ecuador, because they are so strapped for cash that every few hundred million dollars of external financing makes a world of difference," said an emerging market analyst.

"Originally Ecuador was going to issue globals, of which Venezuela was going to buy the majority of the new issue. That way the guarantee would be fairly straightforward, and Venezuela would have a relatively liquid security that would have been pari passu with the other outstanding globals.

"If Ecuador issues local notes, Venezuela gives up that liquidity and that pari passu status," he added.

The analyst is still recommending a neutral weight on Ecuador.

"With oil prices this high, they may be able to squeak by into next year, even if they don't get the cash from Venezuela or the multilaterals. 2006 would still be very difficult, though."

Peru's Kuczynski named prime minister

Peru's outgoing economy minister Pedro Pablo Kuczynski has been appointed prime minister in a cabinet reshuffle - but there was little market reaction to the development.

The move is not surprising since he will be viewed as a conciliatory figure, remarked Alvarez.

Late Thursday, Peruvian president Alejandro Toledo named controversial Fernando Olivera as his foreign minister. In protest, prime minister Carlos Ferrero stepped down. Toledo then asked his entire cabinet to resign.

On Friday, the market showed a relief when Kuczynski said he would stay on board. He is credited for helping turn around Peru's economy.

"They are going to have elections coming up, so it's almost like a caretaker government," noted the buyside source, who said he has little exposure in Peru.

President Toledo swore in a new cabinet with seven new ministers, mostly from his own party.

The buyside source added the he did not expect any major changes to government policy.

"When I saw Kuczynski was going to be prime minister, my first reaction was, 'wow, that's great news.' Apparently, it's not good enough to get the market going.

"But I guess that's partly a function of the slowness [in the market]."

"This seems to be good news, but the market doesn't seem to care."

"Prices are pretty tight. But how high can it trade up on that kind of news. It can only go so far."

The source added that while he likes the Peruvian story, but "the spreads just aren't great."

Even before the cabinet reshuffle, he said he had already begun to scale back his holdings in Peru as well as emerging markets in general.

He added that he is cautious, hoping for some sort of market correction.

"I'm not thrilled with valuations," he said.

"I pulled back to a more defensive position. Sooner or later, prices will correct. Hopefully it's sooner...because I'm short."

Furthermore, he said he expects that Fed activity will pressure the market and the correction will not come from within the asset class.

"Fundamentals aren't that bad. I wouldn't expect to see deep corrections like we saw in the past, but I expect to see some type of correction," he commented.

Fundamentals and the search for yield are helping the market hold on, said the buyside source, who added that he is surprised by the current strong performance.

Meanwhile emerging markets are continuing to see inflows, however the momentum of inflows appears to be decreasing, said a market source.

Sovereigns could soon start to bring their 2006 pre-funding. The incentive to get underway before the end of summer is that emerging markets yields are low right now, and 2006 will be a busy one, politically, for a number of emerging markets countries, said the source.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.