Emerging market debt spreads tighter; Brazil and Turkey up

By Reshmi Basu and Paul A. Harris

New York, May 28 - After a volatile week of trading, spreads on emerging market debt tightened Friday in light trading as investors headed into Memorial Day weekend.

Emerging market debt continued its upward climb for the second straight day, continuing the rebound from Wednesday's decline when a JP Morgan note recommending reduced exposure in Brazil drove down markets.

The JP Morgan EMBI Index tightened by six basis points to 504 basis points by late morning Friday.

Brazilian paper firmed up during Friday's session, a surprise to some who suspected that investors would remain on the sidelines approaching the long weekend.

"The market has been pretty volatile this week," said a sell-side source.

"At one point on Thursday the Brazil 2040s were down two points but ended in positive territory for the day.

"It was a three-point swing from the lows to the highs.

"The bonds are up again today [Friday]. But I don't think people would have guessed that they would be up at these levels on a Friday before a long weekend," added the sell-side source.

The Brazil bonds due 2040 were 90.65 bid, 90.95 offered in mid-morning trading Friday, up half a point from Thursday's close.

Nonetheless, it has been a mixed bag of news for Brazil this past week.

On Tuesday, Brazil reported its jobless rate increased in April to its highest level in more than two years. Unemployment rose to 13.1% from 12.8% in March and 12.4% a year ago for the country's six largest metropolitan areas.

Then came JP Morgan's note on Wednesday.

But then on Thursday, Brazil's GDP numbers sparked an emerging market rally. The country's gross domestic product grew by 2.7% during the first quarter of 2004, exceeding economists' expectations.

Also coming out on Thursday were the minutes from the Brazilian Central Bank's Monetary Policy Committee meeting on May 18-19.

The Central Bank said that rising U.S interest rates created uncertainties for Brazil, which led the Bank to hold interest rates steady.

The Bank also said it is keeping its forecast of an 11.8% increase for oil prices in Brazil in 2004, but would review the figure if supply problems persist.

The Brazilian component of the EMBI tightened by 20 basis points to 692 basis points in late morning trading.

Also gaining Friday were Russia and Turkey. The Russian component of the EMBI tightened one basis to 303 basis points. And one of May's biggest loser's, Turkey, traded seven basis points tighter to 491 basis points.

Investors look to U.S. inflation data

As the volatile month of May comes to a close, investors will eye upcoming U.S. inflation numbers and oil prices for guidance as to how the Fed will act in June. Investors' bumpy ride in May could be followed by a period that is just as unsettling moving ahead.

"From a technical standpoint the market could do better this week," said the sell-side source.

"We're certainly at levels where people will start to get more cautious.

"We could see people starting to take some profit, or going short again.

"There is a lot of potential volatility in June. One investor asked rhetorically 'Do you really do something before the FOMC meeting?'" commented the sell-side source.

The Federal Open Market Committee meeting is set for June 29.

And looking ahead, the market will pay close attention to the U.S. handover of control in Iraq to a new government on June 30.

"People are going to be cautious going into that," said the sell-side source.

CEZ prices

In primary action, Czech Republic national power utility CEZ sold €400 million of 4 5/8% seven-year bonds (BBB+) on Friday. The notes priced at 99.602 for a spread of mid-swaps plus 65 basis points.

BNP Paribas and Merrill Lynch & Co. ran the books.

Coming up from Asia, Singapore's third largest lending institution Oversea-Chinese Bank Corp. is expected to issue $500 million of three-year senior unsecured floating-rate notes.

Citigroup and Deutsche Bank Securities are the bookrunners.

The deal is expected to price during the second half of 2004.

And Ukrainian government-owned oil and gas company Naftogaz plans to issue $700 million of five- to seven-year eurobonds in late June or possibly July.

A market source said the timing of the deal - and whether it would price - would depend on market conditions.

ABN Amro and UBS Investments are the bookrunners for the Regulation S deal.

Brazil, Turkey seen as top risks

Unprecedented levels of geopolitical risk since the Vietnam era will pose a very real threat to the emerging markets, according to Jephraim Gundzik, president of Condor Advisers, which provides emerging markets investment risk analysis.

Brazil and Turkey are the biggest risks in emerging markets right now, according to Gundzik.

"And they have massive amounts of external debt to finance."

"Brazil in particular is being gripped by rising social/political instability, driven by the government's efforts to follow the IMF fiscal model.

"Look at the last 15 years and what it has done. It stunted growth. Instead of stabilizing the debt ratios it caused it to triple," said Gundzik.

Despite Thursday's stronger GDP numbers, fundamentals are deteriorating.

"The poor keep on getting poorer because wages continue to fall.

"In order to alleviate the problem they have to increase public sector spending. That's not going to happen.

"Brazil, in my mind, is biggest emerging market risk," Gundzik told Prospect News.

And Gundzik recommends reducing exposure to Turkey. The country is similar to Brazil in terms of its social and political dynamic. Its geopolitical risk is intensified given its location.

As capital markets reduce their risk, the question becomes, how will the IMF's debtors pay down their debt.

"And they [Turkey] would be much better off doing an Argentine-style default.

"The whole thing is predicated on maintaining access to capital markets or external money," commented Gundzik.

"That is why Turkey is the IMF's largest borrower. Without the IMF, Turkey would be already sunk."

Brazil, Turkey, Argentina and Indonesia are the IMF's biggest debtors with some 70% of the loans outstanding.

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