Emerging markets better as worries ease; Ecuador, Argentina strong; new issues still waiting

By Paul Deckelman and Aaron Hochman-Zimmerman

New York, Aug. 22 - Emerging market bonds were looking better, with investors apparently comforted by the notion that the credit crunch triggered by the U.S. subprime mortgage business meltdown has subsided somewhat, and mollified as well by the prospect that the Federal Reserve may step in again to maintain liquidity, if need be. While no immediate action was forthcoming, the financial press began to speculate on the likelihood that the Fed may cut the key federal funds rate at its September meeting.

The perception that the credit crunch has eased and the Fed will keep liquidity on an even keel using the various methods at its disposal caused stocks to shoot up; investors felt that the promises of sufficient liquidity will allow the wave of mergers and acquisitions seen in the first half of the year, which had ground to a halt in recent weeks, to resume. Treasuries meantime fell and their yields moved up, resulting in significant spread tightening for most emerging bonds.

Ecuador's bonds and Argentina's were among the better performers. Other Latin gainers included Mexico and Brazil.

Elsewhere, Philippine bonds were seen firmer during the local trading session Wednesday and the cost of hedging against a possible default on that paper using credit default swaps contracts declined by several basis points. South African bonds were better, but Turkey was on the downside.

But a calmer disposition in the primary market was not enough to bring any deals to the finish line.

Fears subside

Investors and analysts seem to be smiling again over the direction the market is headed, but the market is still shy of showing any real substance behind the upbeat demeanor.

"It's becoming a little less fearful ... Generally markets are in a better tone today and have been for this week," an emerging markets analyst said.

Wednesday's market performance was encouraging, but not worthy of a full sigh of relief.

"We're in a wait-and-see mode," the analyst added, referring to the potential of further U.S. Federal Reserve Bank rate cuts and fluctuation in money markets.

"In terms of today, a one or two day recovery does not make a trend," the strategist said.

"We're not out of the woods yet," the analyst said.

"The risk remains the same: information opacity related to derivatives exposures," the strategist said, adding: "[with] lenders curtailing a lot of lending, the growth impact can be expected to be negative."

"Demand is not entirely absent; it will likely increase in September, but there will also be a flood of deals on the LBO and EM corporate side, so this could pressure credit spreads," the strategist said.

The analyst agreed with an appropriate amount of hesitation.

The Labor Day holiday in the United States may "be a big factor in either direction," the analyst said.

"There could be a glut of issues in September," the analyst said, highlighting the possibility that "if we get weakness in high yield than EM may follow."

Emerging markets tend to take their cue from other sectors, the analyst said.

The best bets in emerging markets are the most stable issues.

"Generally we're looking at sovereigns," the analyst said.

Spreads tighten

Investors in perceived relatively risky asset classes such as EM paper, high yield bonds and equities were apparently heartened by Tuesday's meeting between Fed boss Ben Bernanke, Treasury secretary Henry Paulson and Senate Banking Committee chairman Christopher Dodd, at which Bernanke pledged to use all the tools at the Fed's disposal to keep credit availability on an even keel - this on top of last week's surprise 50 basis point cut in the Fed's discount rate. The four biggest U.S. banks - Citigroup, Bank of America, JPMorgan Chase and Wachovia - on Wednesday followed the Fed's urging that they take advantage of this resource, and each borrowed $500 million, to inject into the credit system, as an example to other lenders that the liquidity picture has brightened.

With stocks higher, leading the way for emerging markets and other supposed risky asset classes, Treasuries were lower, with the yield on the two-year up 10 bps to 4.16%, breaking a seven-day winning streak.

The yield on the benchmark 10-year note meantime rose 3 bps to 4.64%.

Those rising Treasury yields helped to tighten spreads versus emerging paper, the key measure of investor tolerance of risk, or aversion to it. The widely followed EMBI+ index of emerging debt performance compiled by JP Morgan showed average EM yields tightening by 16 bps on the session to 229 bps.

Ecuador, Argentina lead Latin America

The Latin American sovereign debt market was seen having a firmer tone, led by the bonds of Ecuador, one of the perceived riskier, volatile high-beta credits, along with Argentina and Venezuela.

Ecuador's bonds were seen among the strong performers on Wednesday, with the average spread over Treasuries seen having tightened nearly 50 bps on the session to just under 7.20%.

Argentina was also on the upside, with the benchmark 8.28% dollar-denominated bonds due 2033 quoted 3 points better on the day at 81.5 bid. The CDS contract fell 35 bps on the day to 502.5 bps.

The high-beta names have been seen late leading the market upward on days when it has risen, although they have also been the biggest losers on days when it has fallen, the bonds roiled by political uncertainty in each of those countries.

Mexico helped by equities, peso

Outside of the high-beta names, Mexico was seen turning in a solid performance, in line with stronger equities and a stronger peso in international foreign exchange dealings.

The country's benchmark peso-denominated 10-year bonds were seen up more than half a point to about 100.75, while its yield declined nearly 10 bps to 7.85%.

Brazil, whose bonds are among the most liquid and widely held in the emerging sphere, was also a gainer. Its dollar-denominated 7 7/8% global bonds due 2015 were seen up about ½ point at just under 110.5, while the yield on those bonds fell 7 bps to 6.05%.

Its local-currency denominated bonds were also better, in line with gains in the real on forex markets. The yield on its zero-coupon bonds sue 2008 was quoted down 3 bps at just over 11.30%.

Trader sees no real Latin trend

While Latin debt was better pretty much across the board, a trader in those issues observed that "we're still just following high grade and equities. Certainly, there are no new issues, or anything like that, happening in our market. So in general, it was a sleepy afternoon.

The trader saw CDS levels anywhere from 2 bps to 10 bps tighter for the more liquid sovereign issues, "but I don't think you would say there is anything special driving our market whereas, obviously in high-grade, you're starting to see what I would call a fair amount of issuance for the week before the [unofficial] last week of the summer. But there's no news driving us. We're just reacting."

The trader said that "nothing's happened that's fundamentally changed in EM - it's all just relative value, and in a lot of cases, EM looks expensive to high grade." For instance, while Anheuser Busch sold $500 million of new 30-year bonds at 153 bps over Treasuries on Tuesday, "most of the sovereign bonds in Latin America are still inside of 200 [bps] over Treasuries - Mexico, Peru, even Brazil. It makes us look sort of expensive."

The trader opined that the scary credit crunch in the U.S. from the subprime problems might shake markets elsewhere - but was unlikely to directly damage the emerging trading area on anything other than a temporary basis.

"Unless you decided that all of this is going to lead to a substantial slowdown in global growth, and that's going to affect commodity prices, I think that's the only impact people are deriving out of all of this on emerging markets. You may argue some of that as a result, although we've already seen copper prices come down, and even oil prices come down a little bit, so you can argue that some of that impact has already hit, but beyond that, there isn't subprime exposure in Latin America or Eastern Europe or Asia. The banks don't own subprime debt the way they do in Europe.

However, such market turmoil could - and did - produce a sell off in EM, because "if everything else is going to trade off as much as this has, EM has to trade off too. EM was already very expensive."

Philippines bonds firm, CDS fall

Outside of Latin American dealings, the debt markets in Asia had been seen a little steadier during the local sessions there, helped by the perception that the Fed would help alleviate the credit crunch.

The key issue, the Philippines' benchmark 2032 bonds were seen up slightly from Tuesday's levels to 94.5 bid, 95.5 offered. Meantime, the cost of a five-year CDS contract on those bonds fell by 10 bps, quoted at around 193/197 bps.

South Africa gains on rand strength

Another upsider was South Africa, helped by the signs of stability and strength shown by that country's currency, the rand.

The yield on its key R153 bonds due 2010 was at 9.225%, down from its previous close of 9.250%, while the short-term R196 was bid at a yield of 9.49%, versus its previous close of 9.505%. The longer-term R157 2015 bonds' yield dipped slightly to 8.48% from 8.485% before.

Turkey bonds move lower

But Turkey's volatile, high-yielding bonds - carrying interest rates above 18% - moved upward, with the yield on its benchmark 2009 bonds rising to 18.66% Wednesday from 18.59% on Tuesday and 18.21% during Monday's session.

While the pending presidential vote tally in Parliament looms at the back of some investors' minds - it could produce a showdown between the country's Islamic factions and its secularists - the bonds are also seen vulnerable to any kind of selling wave linked to a downturn in the nation's currency, the lira, as happened last week.

Calm in Asian credit

High liquidity and strong asset quality among Asian banks are enough reasons for a market source to call them "rock solid."

Strong fundamentals make these banks look very attractive as continued volatility is expected through the middle of the fourth quarter of this year, the market source said.

The banks have had healthy, but not excessive loan growth, low exposure to the U.S. subprime market and are funded with strong domestic deposits, the source said.

Korean banks which have been racking up short-term foreign debt are an exception, the source said.

Overall, investors should pay close attention to paper from Asian banks for the next 12 months, the source said.

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