Turkey €600 million eurobond well received; emerging market debt softer; concerns over Selic rate hike

By Reshmi Basu and Paul A. Harris

New York, Sept. 10 - Emerging market debt drifted slightly lower Friday as Turkey priced a benchmark euro-denominated deal.

Supply issues and profit taking were behind the dip during Friday's session. The JP Morgan EMBI+ slipped 0.09%. Its spread to Treasuries widened one basis point to 426 basis points.

In primary action, the Republic of Turkey tapped the bond markets with an oversubscribed deal. The sovereign priced €600 million five-year notes (B1/BB-/B+) at 98.94 to yield 5¾% via JP Morgan and ABN Amro.

The sovereign deal was well received, according to a market source.

Initially the target size was €500 million. But demanded prompted the increase.

However the issuer decided not to exceed €600 million because of fear that too large a deal could derail a future dollar-denominated issue, the source said.

"It was pretty tightly priced. It was flat to dollars and probably was easily inside the euro curve," said the source.

The order book was €1.3 billion.

"They had $1.4 billion to do before this. This leaves them with basically another $750 million deal to do for the year," said the market source.

Prices softer

New supply coupled with profit taking has worn on emerging market prices in recent days.

Among the transactions recently brought to market, Brazil priced an upsized €750 million eight-year bullet (B2/B+) at 98.88 to yield 8.7%. Petrobras sold $600 million 10-year notes (Ba2) at 98.638 to yield 7.95%.

And the Philippines priced $1 billion add-on to two sovereign issues (Ba2/BB) on Wednesday to raise funds for cash-starved National Power Corp., the country's state-owned power monopoly.

"I think some of it is supply," said the market source. "I think some of it is profit taking because people are stepping back and saying, 'What more good news are we waiting for?'

"When you think about it, the Brazil upgrade was pretty much the last thing people had on their list of what good things can happen to the market," added the source.

On Thursday, Moody's Investors Service raised Brazil's foreign currency rating to B1 from B2, saying that expected continued export growth has reduced the country's external debt burden. Recently, Venezuela has also been on the receiving end of a ratings lift by Moody's and Standard and Poor's.

"At this point, [U.S.] Treasuries are pretty strong. I think people feel there is more risk to the downside," the source said. "And then you are going into election season in the States and you also have October elections in Brazil."

Midterm elections for Brazil will be held Oct. 3.

Overall, emerging market paper was down Friday.

The Brazil bond due 2040 slipped 0.125 to 98 bid while the bond due 2040 fell 0.10 to 108½ bid. The Russia bond due 2030 lost 0.125 to 95¾ bid.

"All the supply this week is definitely taking its toll on the overall market but it doesn't look like anything more than a pause as of right now," said an emerging market analyst.

"Brazil '40s are still trading at 108, more than 20 points off their lows in May, so it's not as if the market is in trouble right now.

"But the size and speed of the new issuance took some investors by surprise, especially because everyone knows there will still be billions more in new issuance from Turkey, Russian corporates, Korea, etc.

"The theme through the rest of the month should be what we're seeing now - a decent bid for EM paper, but with the primary market activity putting a floor on spreads," he noted.

Worries over rate hikes in Brazil

Some investors were surprised that Moody's upgrade did little to lift Brazil's bonds. Its paper traded lower Thursday and Friday.

"I think the market was taken a little by surprise, although in the previous weeks we heard about a possible rumor," said a Latin American debt strategist at Refco EM.

"So I think this is the typical story that you buy on the rumors and sell on the news."

But the strategist says the focus on Brazil should revolve around the very real possibility that the Central Bank will hike interest rates during its Sept. 14 - 15 meeting.

The latest inflation numbers from Brazil provide more evidence that the bank will raise the Selic rate from 16%, which has been left untouched since April.

On Friday, the August IPCA inflation numbers came in at 0.69%, above market consensus. And that followed Thursday's industrial production figures showing a 9.6% rise from a year earlier.

Noting these figures, the strategist commented: "They are going to have to eventually raise interest rates.

"You have an economy that is growing better than expected. The aggregate demand is also improving," he added.

Inflation is the main concern for Brazil as prices are starting to move up. But while the impact will be negative, it should minor, he added.

"And I think the market has not quite realized that. We saw yesterday [Thursday], the '40, right after the news, reached 110 and closed by the end of the day around 1081/2.

"You see a little bit of profit taking. If we see interest rates going up, you will see around 105.

"There is going to be some negative effects if the interest rate increases, not only from the point of view of the holder of a fixed-income instrument, but also from the point of view of the slowing down of the economy," the Refco EM strategist told Prospect News.

However, a decision by the bank to keep rates unchanged may also hurt its paper, according to the strategist.

"If they set an objective and they do not accomplish that objective the market is going to take it as a negative because the Central Bank is not achieving its targets.

"I think they will increase the interest rates if we keep seeing the economy growing at the levels we have seen in the past few months and if the inflation numbers continue to deteriorate," he added.

While rate hikes are usually accompanied by negative market reactions, the impact will not be quite as harsh for fixed-income investors, he noted.

"It's a balance. The economy is growing at such a level that I don't think you would generate a major meltdown like the one we saw a couple months ago.

"There will be some uncertainty and you may see some defensive actions before it occurs or right after. But it's not going to have as negative effect overall.

"I think the whole region, including Brazil, is showing that the fundamentals - the macroeconomic discipline and the exports continue to improve.

"And at the end of the day, that's what investors want to see."

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