Emerging market debt tighter despite PPI numbers

By Reshmi Basu and Paul A. Harris

New York, July 18 - Emerging market debt saw a decent tone Tuesday during an illiquid summer session, even as equities spent most of the day in the red and U.S Treasuries saw a sell-off on the back of higher than expected producer price index numbers.

U.S. stocks saw a late afternoon rally, triggered by lower crude oil prices and positive corporate earning reports. Meanwhile the yield on the 10-year Treasury note jumped to 5.13% from Monday's close of 5.07% as PPI numbers signaled inflationary pressure.

The Labor Department reported Tuesday that the headline producer price index gained 0.5%, which was above market consensus. Prices, excluding food and energy, jumped 0.2%, coming in line with expectations.

"EM put in 'an okay performance' on Tuesday," said a trader who focuses on Asian fixed-income names.

He added that the market gave up some of the tightening seen in the early part of the day.

At session's end, the JP Morgan Global EMBI index was narrower by 7 basis points at 209 basis points versus Treasuries.

Small impact from Mid-East tension

In the last week, the crisis in the Middle East has been somewhat impacting emerging markets compared to U.S. stocks. The fighting between Israel and Hezbollah militants escalated Tuesday as one Israeli general said the offensive could last for weeks.

"There is obviously plenty of geopolitical risk out there," remarked the trader.

"The news flow has been bad. But there really has not been a great deal of selling on the back of that," he added.

Even as geopolitical risk cranked higher, Latin American credits appear somewhat impervious, according to Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal.

Higher U.S Treasury yields and a somewhat bearish tone in stocks have not triggered a reduction in Latin American debt positions - although the lack of selling is more explained by sidelined investors rather than a resilient market, noted Alvarez.

"For the most part, the market appears to be short," he said.

"The market is waiting, trying to see what the next big piece of news will be and how that's going to influence the overall outlook."

But that means investors must balance out somewhat more predictable short-term factors such as U.S. data with unpredictable medium- to longer-term events such as the Mid-East crisis or crude oil prices. And those events could prove to be dangerous to the emerging market asset class down the road.

Nonetheless, the latest violence has not produced a whole lot of sellers, observed the trader.

"People have taken the view that this is a relatively containable flashpoint at the moment," he said.

For example, the source said, a lot of the risk premium has been taken away from the oil, gold and commodity markets in general.

"Oil is four or five dollars off. Gold has come off very hard."

Bernanke up to bat

This week, investors brace for a slew of market events, which investors are hoping will shed light on how the Federal Reserve will act at its next meeting in August.

Next on the calendar, Wednesday will see the release of the consumer price index and the start of Fed chief Ben Bernanke's testimony before Congress on monetary policy. And on Thursday, the Federal Open Market Committee will release the minutes from its June meeting.

As investors play the waiting game, trading has been light.

"The positive is that you haven't seen more short sellers," remarked Alvarez, adding that the movement in high beta credits may be a result of short covering.

High beta Latin American names such as Argentina and Colombia saw more volume.

During Tuesday's session, the Argentinean discount bond due 2033 gained 0.60 to 87.60 bid, 88.50 offered. The Colombian bond due 2033 was up 0.30 to 126.10 bid, 126.75 offered. The benchmark Brazilian bond due 2040 added 0.30 to 125.85 bid, 126 offered.

Elsewhere the trader noted that the Philippines five-year paper was 9 basis points tighter at 221 bid, 226 offered on a spread basis from 230 bid, 235 offered. The long end of the Philippines curve was up half a point.

"Indonesia is up a little less because it is still affected by the earthquake and tsunami," he said.

"People are still waiting to see what the damage is there. But even Indonesia credit default swaps are a good five tighter."

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