Emerging market debt tightens ahead of FOMC meeting; Lula's government dealt a blow

By Reshmi Basu and Paul A. Harris

New York, Dec. 13 - In muted trading, spreads for emerging market debt narrowed ahead of Tuesday's Federal Open Market Committee meeting.

"Everything is tighter - at least certain bonds on certain curves," said a buyside source.

Overall, the JP Morgan EMBI+ Index narrowed two basis points to 376 basis points.

The Russia bond due 2030 was up 5/8 of a point to 102¼ bid. The Venezuela bond due 2027 added 0.30 to 103.10 bid. The Turkey bond due 2030 gained 1.44 to 139.94 bid.

"Both street and real money accounts" played Monday, according to the buyside source.

Illiquid names such as Panama and Peru performed well, added the source.

In trading Monday, the Panama bond due 2029 was at 116 bid, up half a point. The Peru bond due 2012 added ¾ of a point to 116 bid.

"Trading was very subdued - nothing major to characterize the session," said Latin America debt strategist Enrique Alvarez of think tank IDEAglobal.

"Brazil is mixed at best - maybe up a little bit in the '40s," he added.

Lula's Workers' Party weakened

In a blow to president Luiz Inacio Lula da Silva, the Brazilian Democratic Movement Party has decided to break ties with the president's Workers' Party. This comes a day after the Popular Socialist Party ended its support.

Despite the setback, one trader remains bullish on Brazil heading into 2005.

This trader professed the belief that neither rising interest rates nor an anemic dollar would ultimately do damage to Brazil.

"With interest rates in the U.S starting to climb, there will be some pressure on Brazil," the trader contended.

"But I believe that is going to create a buying opportunity.

"Last month Brazil reduced the external its external debt by $3 billion. And the declining dollar versus the euro, has helped U.S dollar-debt countries.

"If Lula can keep the government together you can look for a credit upgrade for Brazil in 2005.

"And remember, not long before Lula was elected in 2002, the Brazil global 2040 had traded all the way down to 43.00 bid. Look where it is just 24 months later.

"To me Brazil appears poised to outperform in 2005," he said.

The Brazil bond due 2040 was trading at 115½ bid, 116½ offered late Monday, "up a point".

Meanwhile the C-bond lost 3/8 of a point to 101 bid.

Eyeing the FOMC's language

It is a foregone conclusion that the Federal Reserve will raise interest rates by a quarter of a percentage point at Tuesday's meeting. But investors will be paying close attention to the accompanying statement as they search for changes in the text that may predict the Fed's next move.

"You are looking to see what they say in the overall communication where they try and pinpoint risk and if there is anything new in that sense, especially if they point out any additional or change wording regarding inflation or anything like that," noted Alvarez.

The same can be said for Brazil. The monetary policy committee (Copom) meets Wednesday. The street expects a half a point hike to a 17.25% Selic rate.

"You are in the same holding pattern for Brazil. People are going to be analyzing very thoroughly what the Central Bank says there, also," he said.

However, the holidays are in sight and beginning to slow activity.

"Once you get past the 15th of the month, things begin to get very quiet and wind down," said Alvarez.

"Normally, people want to take on less risk towards the end of December. They are pretty well balanced or at least at a point where they are holding some sort of comfortable portfolio mix up until the start of next year.

"You are starting to see that sort of characterization in the market," he concluded.

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