Emerging markets firm; Ecuador to default on 12% bonds; week ends with light trading volumes

By Aaron Hochman-Zimmerman

New York, Dec. 12 - Emerging markets closed the week with weak volumes and a relatively strong tone, but Ecuador's impending default dominated market conversations.

President Rafael Correa announced that his government would not make Monday's $31 million payment on its bonds due 2012, despite its ability to pay.

The bonds, which have recently traded at or near default levels, sank 7 points and helped sink the credit of Ecuador's high-beta neighbors in Latin America.

"It's as [bad] as it's been," a trader said about the larger picture of the market, but still, in many cases, issues insisted on climbing higher.

However, over the course of the week ended Wednesday, the category suffered the loss of $829 million, which flowed out of emerging market bond funds, according to data compiled by EPFR Global.

Meanwhile in the major markets, equities waffled as debate raged over the bailout of the U.S. auto industry, while volatility fell by 1.50 to 54.28, according to the VIX index. The index is a frequently used gauge of market volatility.

As a sector, emerging markets managed to narrow by 6 basis points to a spread of 720 bps, according to JPMorgan's EMBI+ index. The EMBI+ calculates the amount of extra yield investors will accept to hold assets in emerging market debt.

Ecuador to default

Ecuador president Correa declared that his government will default on a $31 million payment due on Monday for the 12% bonds due 2012.

Market watchers were aware that this was a decision not to pay, rather than an inability to pay.

As many have always expected, Correa is likely to favor social spending over servicing the debt he has often called "illegal."

Conflicting statements about the country's intention to pay were thrown all over the market in the month-long grace period between the bond's scheduled coupon payment date on Nov. 15 and the expiration of the grace period.

The Ecuadorian bonds due 2012 were quoted lower by 7 points at 24 bid.

LatAm pressured by Ecuador

Ecuador's close political ally Venezuela was caught between another drop in oil prices and the default, which monopolized the attention of emerging market traders.

Many believe that the default may create a fissure between left-leaning leaders president Hugo Chavez and Ecuador's Correa.

Also in Venezuela, government prosecutors filed charges against one of Chavez's key rivals, Manuel Rosales.

The charges surround alleged misuse of lottery revenues when Rosales served as state governor of Zulia.

Critics of Chavez believe that the charges are entirely politically motivated.

Light sweet crude was seen trading as low as $44 per barrel.

The 9¼% Venezuelan government bonds due 2027 sank 4.5 points to 55.5 bid.

In Argentina, subway workers walked off the job on Friday even as a federal court threatened to issue an order that would ensure the trains in Buenos Aires would run.

Government officials were scheduled to meet with labor leaders to discuss the planned two-day strike, according to the Buenos Aires Herald.

The 8.28% Argentine discount bonds due 2033 fell 1 point to 27 bid.

Europe holds in

Emerging Europe continued its streak of staying untarnished by the mess outside of emerging market credit, a trader said.

"The bigger picture is negative," he said, but "the micro picture is actually quite strong ... people want to buy bonds."

Russia's sovereign and corporate bonds held their value amid equity and currency trouble on Friday, while president Dmitry Medvedev made overtures toward OPEC.

"I hear requests to conduct a coordinated policy," Medvedev said about OPEC, according to the Itar-Tass News Agency.

"I'd like to tell them we're ready for this because we must defend the sphere that's our common base - I mean both oil and gas," Medvedev said.

The ruble was seen trading at 27.710 to the dollar.

The Russian sovereigns due 2030 were quoted at 81.75 bid.

Elsewhere, in Turkey, the government has formed a panel of economic leaders in order to attract investment capital from the Gulf States, the Hurriyet Daily News reported.

As markets suffer in the United States and the European Union, Ankara hopes to bring as much as $15 billion annually into the economy from countries such as Saudi Arabia, Kuwait and the United Arab Emirates, the report said.

Investment power from the Gulf States may reach as high as $2.5 trillion.

Asia softer with overnight equities

Asian credit was generally stable on low volumes, but prices were slightly weaker on Friday as equities in the local markets were smashed overnight.

In the Philippines, the central bank published a list of eight banks held in receivership by the Philippine Deposit Insurance Corp., according to a statement from the bank.

The central bank is investigating the banks to determine if any further action will be taken.

The central bank added that "these banks represent only a tiny fraction of the banking system and that this reaffirms the BSP's assessment that the banking system remains stable, highly capitalized, and highly liquid," the statement continued.

The Philippine government bonds due 2030 slipped 2 points to 107 bid.

Meanwhile, Indonesia's central bank expects inflation to end at 11% for 2008, below the 12% target it set for the rupiah.

"We will keep working on boosting the real economy and hope local economic conditions will improve next year," said senior deputy governor Miranda Goeltom, according to the Jakarta Post.

The rupiah was seen trading at 10,945.50 against the dollar.

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