Markets steady ahead of FOMC; Brazil off as Palloci resigns; Ukraine wider on election results

By Paul A. Harris

St. Louis, March 27 - Emerging markets held in against a backdrop of weaker Treasuries on Monday, as market players focused squarely upon the Federal Open Market Committee as it prepared to meet on Tuesday.

It will be the first time new Fed chairman Ben Bernanke heads the FOMC, which is widely expected to produce a 25 basis points increase in the Fed Funds target rate, taking it to 4.75% from 4.50%.

However the expected accompanying statement on the outlook of the U.S. economy was the source of much speculation Monday as players said a lot could be riding on what that statement portends in terms of short term rates going forward.

Meanwhile headline news caused the Brazilian curve to ease and Ukraine to widen.

Palloci exits Brazil's government

Late Monday sources in New York told Prospect News that they were accepting the final end for Brazil's embattled finance minister, Antonio Palloci, as an accomplished fact.

An ongoing probe into graft allegations was said to have reduced Palloci's ability to lead the economy and was also impacting his personal life, according to reports from the Brazil press.

Palloci may have handed his resignation letter to Brazilian President Luiz Inacio Lula da Silva (Lula) as early as last Thursday, one source said on Monday.

One trader saw the entire Brazil curve a little lower late Monday on the Palloci news.

This source spotted Brazil's benchmark 11% dollar-denominated bonds maturing in August 2040, said the be the most liquid issue in the emerging markets asset class, going out at 129.90 bid after having traded around 130.20 bid on Friday.

The source, adding that the bond got as low as 129.25 bid Monday morning and was set to end on the higher end of the day's range but down slightly on the day.

The trader commented that the Palloci news had an unsettling overall effect on the market, but "in the end the market actually looks like it will take the news okay.

"In general emerging markets were okay in terms of spread against a backdrop of weaker Treasuries," the source added.

The rumor mill holds that Lula may choose either Workers' Party senator Aloizio Mercadante or state development bank president Guido Mantega as Palloci's replacement.

A sell-side source said late Monday that the neither potential replacement would represent the market's first choice.

GOL talks perpetual at 8¾%

The sell-side source went on to say that the corporate deal now in the market from Brazilian regional air carrier Gol Linhas Aereas Intelligentes was going well.

Gol has given guidance on its $250 million offering of perpetual non-call-five notes (Ba2) of a coupon in the 8¾% area. The deal is expected to price during the middle part of the week via Morgan Stanley and JP Morgan.

However the source said that owing to the FOMC meeting Tuesday it is highly unlikely that terms on the Gol deal will be heard before Wednesday.

Early Monday morning before the New York open, a source in Europe told Prospect News that the Gol order book was at that time approaching $200 million.

Peru: pricing in political noise

Also lately impacted by political headlines has been the debt of Peru, where general elections are set to take place on April 9.

Throughout the Monday session sources seemed resigned to the emergence of presidential candidate Ollanta Humala, a leftist and a former military officer who is campaigning on a platform of higher taxes and tighter restrictions on foreign investments, as the front runner.

Last week Humala had reportedly been running neck and neck with Lourdes Floures, a center-right lawyer who is seen as pro-business.

A market source told Prospect News on Monday that Humala was recently quoted as pledging to potential voters in a northeastern jungle village that "We are going to change the rules for the rich and redistribute wealth."

Humala's rhetoric and rising fortunes have caused Peru's bonds maturing in 2033 to sell off from a high of 122.75 bid during the market rally earlier this year to recent lows of just above 110 bid.

However on Monday a trader spotted the bonds higher at 112.0 bid, up from 111.25 bid Friday close.

The trader commented that Peru has been an underperformer in emerging markets for the past couple of weeks, but the market has adjusted a lot during that period.

Hence Humala's ascendancy, market unfriendly or not, may be priced in.

Ukraine widens

On Sunday Ukrainians elected a new parliament.

A market source noted that exit polls showed the opposition party, Viktor Yanukovych's pro-Russian Party of Regions, obtaining approximately 33% of the votes while ex-prime minister Yulio Tymoshenko came in second with around 23% and the president's party, Our Ukraine, trailed both with 13.5%.

A possible outcome would be a coalition between Our Ukraine and the ex-Orange team led by Tymoshenko, who was dismissed as prime minister in September 2005 by president Viktor Yushchenko.

Tymoshenko is seen as something of a socialist, and has been critical of the natural gas deal between Ukraine and Gazprom. Hence she is seen as something of a destabilizing political and economic force.

A scenario in which Our Ukraine teams with the opposition Party of Regions, which could ease the tensions between Russia and Ukraine, enabling Ukraine to have a stable energy supply, is seen as a possible outcome.

Because of rules laid out during the Orange Revolution, the Ukrainian parliament, the Rada, has 30 days to form a coalition and 60 days to appoint a cabinet. Failing that the president has the right to call fresh elections in 90 days.

The source added that Sunday's elections in the Ukraine appeared to come off without violence or widespread allegations of vote rigging.

Nevertheless a source told Prospect News late Monday that the Ukraine EMBI component was trading at a spread of 182 basis points, three basis points wider on the session.

Parsing the Fed

As the session unfolded sources professed a keen interest in Tuesday's Federal Open Market Committee meeting which will be the first one under new Federal Reserve chairman Ben Bernanke.

Although the FOMC is roundly expected to hike the short term rate by 25 basis points to 4.75%, emerging markets players will be keenly tuned into what is contained in the FOMC's accompanying statement regarding a possible end to the present tightening cycle.

A trader who focuses on Asian fixed income said that the Monday market was very quiet, with a soft tone early on but no follow through, as people waited on the FOMC

The source added that the more liquid long ends of the Philippine and Indonesia curves were perhaps a quarter of a point or so lower, but the flows were not significant as people were marking prices lower to reflect the headline impacting Latin American credits and emerging markets generally.

Prospect News asked this trader whether there will likely be a sell off in emerging markets should Tuesday's FOMC meeting not produce some indication that the current round of interest rate tightening could be coming to a close.

The trader, characterizing the anticipated Tuesday FOMC statement as "fairly important," said that the market figures to do better on the back of "dovish comments" from the Fed.

"The market is really hoping for some light at the end of the tunnel," the trader said, referring to a possible - and, to some, a highly anticipated - pause to the regime of rate hikes.

Absent evidence that the Fed will pause, emerging markets won't get hurt unless the lack of a pointer intensifies the sell-off in Treasuries, the source added.

The trader said that the 10-year Treasury traded "in a 10-tick range" on Monday, between a yield of 4.68% and 4.72%, with the government benchmark going out at 4.70%.

"As long as these latest ranges hold, we'll obviously trade defensively and weaker but it won't be catastrophic," the trader said.

"But if the sell off in Treasuries intensifies I think things could get more difficult."

The trader said that the market would be listening for language that would indicate that future rate hikes will be guided by data, as opposed to indications that the FOMC will keep hiking rates in the now-familiar "measured fashion," a statement that the market could react to negatively

A sell-side official, meanwhile, also said that Tuesday's FOMC statement could be pivotal, and noted that at 4.70% the 10-year Treasury is already trading inside the anticipated 4.75% Fed Funds rate that is expected to result from Tuesday's FOMC meeting.

"The market has already priced in the fact that the Fed Funds rate is going to go to 4.75% on Tuesday.

"With the 10-year Treasury going out below 4.75% on Monday it would suggest that there may be an expectation that the Fed is going to make some market-friendly statement on Tuesday," this official said.

"But the market is also pricing in a pretty high probability that the Fed Funds rate is eventually going to hit 5%."

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