Emerging markets steady despite equity drop; Brazil lower, Argentina off; funds see $75 million inflows

By Paul Deckelman and Aaron Hochman-Zimmerman

New York, Aug. 30 - While U.S. stocks fell on Thursday on renewed fears over the lingering effects that the subprime mortgage sector meltdown may have on the economy in general and lending institutions in particular, emerging market bonds were seen generally little changed on the session, as investors awaited Friday's much-anticipated speech by Federal Reserve Chairman Ben Bernanke, which could provide some guidance to the financial markets on the central bank's intentions vis a vis interest rates.

Brazil's bonds were seen lower, in line with a decline in that country's currency unit, the real. Argentina's paper was also easier. Other downsiders, pushed lower by inflation concerns, were India and South Africa. But earlier in the day, Philippines bonds were seen having firmed smartly, after that country reported considerably stronger-than-expected economic growth.

Primary stays quiet

For another day the primary market decided to stay in bed.

With a rising VIX index, which jumped 1.38 to close at 25.19 and a three-day weekend ahead, investors did not find any excuses to force new deals through the pipeline.

However, $75 million managed to come into emerging markets this week, according to EPFR Global.

This week is also the first in three months for inflows in high yield, which totaled $268 million. Investors seemed to pull that money from other places including $6 billion out of money markets, according to EPFR Global.

Despite the inflows, many investors look to be waiting beyond U.S. Labor Day and viewing the actual beginning of the fall season as Sept. 18 when the Federal Reserve Bank will make a decision about a possible rate cut, an emerging markets syndicate official said.

"It'll be an interesting fall with all the high yield backlog," said the syndicate official.

"Things could get better could, or they could get worse; it's pretty hard to tell," the official added.

Announcements from other central banks scheduled for later in September are highly anticipated as well, a market source said.

The market source expects more bad news regarding the U.S. subprime market and a continuation to the elevated volatility numbers.

Darkest before the dawn

A market source called the current state of affairs in credit "very positive" for emerging markets.

If the world's central banks are able to stave off a full recession, emerging markets may surface with buying opportunities, the source said.

Another market source said issues from Latin America are mispriced enough to create opportunities.

The persistent volatility has kept investors away during over the summer months, but once stability returns the Latin American issues will perform very well, the source said.

High levels of liquidity will allow these issues to survive the rollercoaster of volatility, the source added.

Emerging markets relatively firm

Even as equities declined when Lehman Brothers warned that rising credit costs may reduce bank profits, U.S. Treasury issues rose on a renewed flight-to-safety response by investors. They shunned asset-backed commercial paper, suddenly perceived as risky, in favor of short-term government paper, with the yield on the 3-month Treasuries accordingly falling 21 basis points to 3.80%. The yield on the two-year Treasury note fell 5 bps points to 4.09%, and the yield on the benchmark 10-year federal paper fell almost 5 bps to 4.51%.

However, that did not produce too severe a widening out of the average spreads between those Treasury yields and the yields of various EM country bonds, or of the asset class as a whole, the key measure of investor tolerance of increased risk or aversion to it. The widely followed EMBI+ index compiled by JP Morgan & Co. was quoted as having widened 2 bps to 228 bps. The index indicated that overall EM returns were 0.12% better on the day.

A New York-based trader in Latin American bonds said that from where he sat, "nothing stood out," and most issues were trading about where they had been on Wednesday, when the EM sector overcame its early weakness and pushed higher on the back of stocks, as investors speculated about the possibility of a rate cut by the Fed, either at its next meeting in mid-September, or perhaps even before that, should the central bank feel the need to calm the financial markets and make more credit available. Fed boss Bernanke may shed some light on the bank's thinking Friday when he addresses the Kansas City Fed's annual economic symposium at Jackson Hole, Wyo.

"There was nothing really trading here," the trader continued. "A lot of guys were wrapping up their end-of-month and end-of-quarter dealings," especially ahead of Friday's scheduled abbreviated trading day (The Securities Industry and Financial Markets Association has recommended that U.S. fixed- income markets officially close at 2 p.m. ET ahead of the Labor Day holiday weekend, which will also keep all Stateside financial markets completely shuttered on Monday).

He said that as quiet as it was, Friday's partial session promises to be even deader.

"I can't imagine that anyone will really be doing anything" Friday, he opined.

Brazil reverses gain

Among specific issues, Brazil's widely-traded benchmark 11% dollar-denominated bonds due 2040 were seen having given up their early gains to end slightly lower on the session, quoted just below 132. Its 7 7/8% global bonds due 2015 retreated around 1/3 point to the 111.1 area, its yield some 7 bps wider at 5.94%.

Venezuela's benchmark 9¼% bonds due 2027 were seen ½ point easier at 99, while their yield rose 5 bps to 9.36%.

Argentina's bonds were also seen having eased, giving up some of the gains they had notched on Wednesday when they led the EM segment higher. Its inflation-linked Discount bond in pesos was quoted as having declined to 111.6, with its yield widening by 9 bps to 8.52% , while the Argentine Par bond in pesos closed at 40.75, with its yield seen up 6 bps to 7.69% .

Philippines gain on good growth news

Outside of Latin America sphere, Philippine sovereign bonds were seen up solidly earlier Thursday, encouraged by the emerging markets and equity rallies seen during the North American trading session on Wednesday, thought of as the overnight period in the Far East, as well as by a government report of stronger-than-anticipated growth during the second quarter.

During the local trading day in Asia, the country's benchmark 2031 issue was quoted at 106.625 bid, while its 2032 bonds were pegged at 96.5, both up about a point from Wednesday's levels.

Meanwhile, the price of hedging against a default in the bonds via a credit default swaps contract narrowed by 15 bps from where it had been on Wednesday, down to about 180 bps.

The bonds took off after Manila reported that the national economy grew by 7.5% in the second-quarter, one full percentage point above the 6.5% growth rate most analysts were expecting. It was the fastest economic growth pace in nearly two decades, since late 1989, and touched off a strong advance in Philippine stocks, up their most in three weeks. Bonds and shares were also seen to have gained on speculation - reflected in other global markets - about a possible Fed rate cut.

India eases on inflation warning

India's bonds were seen lower for a third consecutive session after an inflation warning from that country's central bank.

Its 7.49% rupee-denominated notes were quoted down about 0.10 to just below the 97 level, while the bonds' yield edged up to just under 8%.

That retreat followed the Reserve Bank of India's release of its annual report, in which it cautioned that farm production shortfalls and deficiencies in infrastructure such as the power grid and the transportation network could push up prices, worsening an inflation rate which is already higher than those of most other large-nation economies.

New Delhi is trying to bring inflation down to a 4% target, but the central bank said that this might be difficult due to such factors as rising costs for food - a by-product of the farm production problems -oil, financial assets and property.

The central bank has raised interest rates nine times in almost three years in order to hold down the rate of inflation, which hovers just below 5% on an annual basis.

The bank's report said that "a continuous vigil supported by appropriate policy actions by all concerned would be needed to maintain price stability so as to anchor inflationary expectations on a sustained basis.

Inflation continues to roil South Africa

For a second straight session, South African bonds were being pushed down by investor reaction to unfavorable inflation news. As had been the case on Wednesday, they were exiting positions on a belief that another interest rate hike by the central bank is now all but guaranteed.

The key government R153 bond due 2010 was seen yielding 9.265%, up from its previous close of 9.170%, while the short-term R196 had a bid yield of 9.560%, widening out from its previous close of 9.430%. The longer-term R157 bond due 2015 was yielding 8.540%, up from 8.445% previously.

The government reported that the nation's producer price index rose by 10.3% year over year in July from a 10.4% year-on-year increase in June. While that data would seem to be a positive, since inflation did slow, most economists were expecting a bigger drop to around a 9.6% rate.

Current inflation rates, real or projected, represent a significant deterioration from where things stood a year ago, when inflation was measured at 8.2%.

On a monthly basis, the PPI rose 1.6% after June's monthly increase of 2.1%.

On Wednesday, Statistics South Africa reported that the core consumer price index, excluding mortgage rate changes, was up 6.5% year on year in July versus the 6.4% rise seen in June, while month on month, the inflation gauge rose 1.1% in July, more than double the 0.5% increase seen the month before, raising investor fears of another central bank rate boost. The central bank - trying to drag surging inflation back to within its target range of 3% to 6% each year - has upped its benchmark lending rate to 10%, the highest it has been in four years.

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