Emerging market debt underperforms as Treasuries rally; investors await coming U.S. data

By Reshmi Basu and Paul A. Harris

New York, Jan. 28 - Emerging market debt underperformed Friday despite a U.S. Treasury rally sparked by lower-than-expected GDP numbers.

Economic growth in the United States slowed to 3.1% in the last quarter of 2004, hampered by a record trade deficit. That news helped embolden the Treasuries market. The yield on the 10-year Treasury note stood at 4.14% by the end of the day Friday, down from 4.23% at Thursday's close.

However, emerging markets were unable to gain momentum, hindered by too much recent supply.

"The market traded disappointedly today [Friday] because you had a good day in U.S. Treasuries with yields coming down to 4.14 [%] and a very solid move in the Brazilian real," said Enrique Alvarez, a Latin American debt strategist for think tank IDEAglobal.

"None of that was able to build an incentive for Latin America to go any higher," he said.

By the close, the Brazil C bond had added 0.062 to 102¼ bid while the bond due 2040 was up 0.15 to 115¼ bid. The Ecuador bond due 2030 lost 0.10 on the day to 92 bid. The Mexico bond due 2009 moved up 0.50 to 121½ bid. The Venezuela bond due 2027 fell 0.05 to 102.80 bid.

Technicals, coupled with the anxiety over the hawkish minutes from Brazil's Central Bank, have created a cautious tone to the market.

On the supply and demand side, this week alone saw $3.4 billion in new sovereign paper.

Peru added $400 million in the reopening of its global bonds due November 2033 (Ba3/BB/BB). The retap priced at 106¾ to yield 8.137% via Morgan Stanley and Deutsche Bank.

New paper also came from the Republic of Hungary. The sovereign priced its upsized $1.5 billion 10-year global bonds (A1/A-) at 99.669 for a spread of 57 basis points more than Treasuries. Morgan Stanley and Deutsche Bank were also lead managers for the sale.

The Republic of Philippines priced an upsized $1.5 billion of 25-year bonds at 98.131 to yield 9.70% Wednesday via UBS, Deutsche Bank and Citigroup.

"I think we may be a little bit overextended. I think people are a little worried about the latest Copom minutes, saying that they intend to keep raising interest rates to a higher level," added Alvarez.

"If you compare that with the rally today [Friday] in the Brazilian real, it could be that looking forward you could see some more political noise on the phenomenon of a rising currency and rising rates, which in turn could cool the [Brazilian] economy," said Alvarez.

Meanwhile, trading in Eastern Europe was nonexistent, according to a buyside source.

"Eastern Europe was really dead. And the runs I saw today [Friday] on Latin America were pretty lackluster, although I was told that a lot of stuff traded yesterday [Thursday], which kind of cleared out a lot of dealers," said the source.

"The market is pretty wide right now. The EMBI-plus is getting hit today pretty hard," the source said, noting it was at 371, having widened from 365 on Thursday.

"It's probably a case of the market not rallying with Treasuries. We had strengthened so much through the rest of the week that it looks like we're going to be flat, dollar price-wise in EM, which, given the rally in Treasuries, today [Friday], would be quite a widening.

"I don't seem many negatives in terms of performance," remarked the source.

The Russia 2030 was as high this week as the investor had ever seen it.

"It's still at 104.50, up half a point," added the source, quoting Friday's level.

Meanwhile, the Turkey bond due 2030 was unchanged at 142 bid.

Looking to economic data for direction

Moving ahead, the market will be on hold as it faces the coming week's important spate of economic data coming out of the United States, according to sources.

"Too many numbers and too many uncertainties," said Alvarez.

"You have FOMC. You have unemployment figures. So in that sense, the market did not want to take any chances either."

Movement will remain in a narrow range, remarked Alvarez.

"The range has been getting tighter and towards the upper end of what we have been witnessing. I think we are to a point to where the uncertainties keep piling on.

"You don't know when we are going to have more issuance or in what size, though the candidates are decreasing as days go by," he said.

"Flows are still good. You still have money in balanced funds. But that does not necessary mean that all the other external factors are constructive."

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