Emerging market debt sees red as concerns pile up; Mexico hit by election uncertainty

By Reshmi Basu and Paul A. Harris

New York, July 5 - Emerging market debt slid Wednesday on a dollar basis as a number of worries came into play, shaking investor confidence.

The asset class ticked lower as issues such as Mexico's election crisis and North Korea's missile launch tested investors' appetite for risk.

Meanwhile emerging markets saw little support from core markets, which also recorded losses. Worries over North Korea's nuclear ambitions as well as surging crude oil prices sent U.S. equities lower. The Dow Jones Industrial Average index gave up 76.20 points.

U.S. Treasuries also recorded losses on the back of U.S. economic data that showed solid growth in private-sector jobs, thereby raising investor expectations that the Federal Reserve will continue to hike rates at its next meeting in August.

By session's end, the yield on the 10-year Treasury note had shot up to 5.22%. Nonetheless, the emerging markets asset class was fairly resilient, observed a market source in the mid-afternoon.

The source noted that U.S. government bonds were also down Monday, but the impact on emerging markets was negligible.

"A lot of EM traders in New York were out on Monday, so things are just beginning to pick up.

"Since [Wednesday] morning major benchmarks such as Brazil and Mexico have been slightly wider. But the market has been fairly flat," the source remarked.

At session's end, the JP Morgan EMBI Global index was down by 0.36% while spreads were unchanged at 212 basis points versus Treasuries. Underperformers included Argentina, Brazil, Russia and Turkey. Brazil's component of the index fell 0.88% while Turkey was down by 0.51%.

Uncertainty lingers in Mexico

Meanwhile, jitters churned higher as the worst-case scenario in Mexico came to fruition with the disputed presidential election yet to produce a clear winner.

On Monday, local markets saw a relief rally on news that the conservative Felipe Calderon had a narrow lead over left of center Andres Manuel Lopez Obrador. But that rally was reversed Wednesday on news that Obrador has now snatched a narrow lead following a recount of 53.8% of ballot results, according to the Federal Electoral Institute.

As a result, local markets took a hit with the Bolsa index losing 4%, thus halting a five-day winning streak. Furthermore, the Mexican peso has erased gains from the previous two sessions.

"The initial reaction in Mexico has been very positive, despite the worst-case scenario that everybody feared, and the peso remains stronger than it was before the vote, and spreads are a good 10 bp lower," according to an emerging market analyst before the release of the partial recount results.

"I think a lot of the sell-off today [Wednesday] has to do with weaker external markets, although some portion is a wave of profit taking on USD shorts set up on Monday," he added.

Nonetheless, Calderon is expected to regain the narrow lead as the vote counting continues due to the geographic progression of the recount, according to an analyst note.

Just how many legs the sell-off has will depend on what tactics Obrador and his party, the Democratic Revolution Party, will utilize in their attempt to win the election, observed Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal.

Furthermore the analyst noted that protesters for Obrador have been in the hundreds, not in the hundreds of thousands. The market would really need to see those kind of numbers before it gets concerned that political violence could break out.

"We're recommending investors take profits in the Mexico overweights we've been recommending and move to neutral weight until the outlook clears up. Still think it's too early to go to underweight.

"On the peso, we're recommending taking profits in USD shorts and moving to flat, though a more clear outlook on the political front would probably help the peso to extend its rally," the analyst noted.

Nonetheless, uncertainty is weighing heavily on the country's bonds. During the session, the Mexican bond due 2034 gave up 0.75 to 97.75 bid, 98.25 offered.

Venezuela to issue for Argentina

In primary market news, the Bolivarian Republic of Venezuela is planning to place a benchmark-sized issue of global bonds, according to an informed source, who specified that proceeds from the deal would be shifted to the Republic of Argentina.

Credit Suisse will be the bookrunner, according to the source, who added that Venezuela apparently does not want the deal to be led by a United States-based bank.

Rumors had circulated that Morgan Stanley would be involved. However Morgan Stanley's status, in light of Venezuela's stipulation regarding U.S. banks, is unclear.

Local papers are reporting that the international issue will be no smaller than $2 billion and will likely take place between August and December.

Argentine president Nestor Kirchner announced plans for the "binational bond" after meeting with president Hugo Chavez on Tuesday.

"The actual debtor status is still in question," said Alvarez.

"There's an idea of Argentina to issue some paper and using Venezuela as sort of a curtain and using its credit rating to get better terms. Who the receptor market for that would be is somewhat sketchy because they are saying that some of it will go to the domestic Venezuelan market," he said, adding that a stab at international markets will be complicated because a deal like this is unprecedented.

Furthermore, there are all types of rumors regarding size and timing, he added.

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