Emerging market debt slammed as 10-year Treasury hits 4½%; voracious appetite for Asian paper

By Reshmi Basu and Paul A. Harris

New York, March 9 - Emerging market debt suffered big losses Wednesday as U.S. Treasuries took a beating from rising inflation concerns.

Surging oil prices and the Beige Book survey in the United States ignited a correction in the Treasury market, pushing the yield on the 10-year note above 4½%, the highest level since July.

In its Beige Book, the Federal Reserve reported that the U.S. "economy has continued to expand at a moderate pace" with solid consumer spending and continued growth in factory output.

But the report's outlook on inflation was mixed. The Fed said that in general, "retail prices were generally flat or up modestly." But many of the 12 Fed districts also cited "persistent pressures on input costs" although some said the pressures had waned since January.

"Sustained increases in the cost of energy, steel and other materials were widespread," the Fed said.

That was enough to send Treasuries tumbling, as many fear that higher inflation would also prompt a more aggressive monetary policy from the Federal Reserve.

A sellside source said that prior to the release of the Beige Book, Treasuries had been trading in a range of seven basis points. After the release, the yield on the 30-year bond blew out 11.5 basis points in the late afternoon from Wednesday's close.

At the end of Wednesday's session, the yield on the 10-year note stood at 4.52% from 4.39% Tuesday.

"The market was very strong until the last hour. Then with Treasuries down another half-a-point to a point everything's giving it up," said a trader.

"There is still good sponsorship. But the 10-year is down now 31.5 ticks. That's a pretty pronounced move. No high-yielding asset class can shake that kind of move off."

Emerging market debt skidded on the Treasuries plunge. The Brazil C bond fell ¾ point to 101 1/8 bid while the bond due 2040 fell 2.65 to 115 bid. Mexico's bond due 2009 dipped 0.45 to 119.85 bid. The Russia bond due 2030 slipped 1.562 to 104 ½ bid.

With the Treasuries sell-off, paper from the Philippines ended its rally. The bonds due 2025 were spotted at 113 1/8 bid late Wednesday, down from Tuesday's close of 114 5/8 bid.

"Emerging markets have obviously been underperforming," said the sellside source.

He noted that on Tuesday, certain issuers were outperforming U.S. Treasuries, but on Wednesday that was no longer the case.

"You can see everyone is performing the same as the Treasuries."

"Most of the spreads are widening, but not by that much - considering that they are at all-time tights. The UMS is not much of an EM issuer. But the 30-year was trading yesterday [Tuesday] at 180 basis points. Now it's trading at around 185. They're still underperforming Treasuries but they are still keeping their tights," he commented.

There will most likely be more repercussions for emerging markets during Thursday's session, he added.

"To have a 12 basis points widening in Treasuries will not go unnoticed."

Voracious appetite for Asian paper

However investors are hungry for Asian paper as the search for yield continues.

The proposed $300 million (Baa1//A-) of perpetual bonds from ChinaTrust Commercial Bank of Taiwan is said to be attracting a billion-plus in orders.

Meanwhile, price guidance for Noble Group's and Titan Petrochemical's proposed issues surfaced Wednesday.

Noble Group has set guidance for its $500 million 10-year notes (Ba1/BB+) at Treasuries plus 225 to 237.5 basis points. Titan Petrochemicals Group Ltd.'s $400 million of seven-year senior unsecured notes (B1/B+) are talked at a yield in the 8½% area.

JP Morgan is running the deals for both ChinaTrust and Noble. Morgan Stanley is running the books for Titan. Credit Suisse First Boston is the co-manager.

The book size for Noble was at $1 billion on Tuesday and rising, according to a market source.

"Even with U.S. interest rates spiking over the last week or so, rates remain low on a historical basis, and that means the search for yield will continue," said an emerging market analyst.

"Neither of these new issues appears very attractive on an absolute basis, but that doesn't really matter in this environment where investors are desperate for anything with a little yield.

"It will take rates moving at least another 25 bps higher, together with continued heavy new EM issuance, to really break the demand for new Asian paper," added the analyst.

New deals lift secondary

The new supply is helping boost price action for Asian paper, according to the trader.

"It's the craziest thing you ever saw. A deal will be 10-times oversubscribed," the trader said.

"People will ask for $20 million of bonds and get $5 million, so they'll go into the secondary market and pick up anything they can because they need to put money to work.

"Supply actually seems to be driving prices higher and spreads tighter," added the trader.

The Asian issuers now face the challenge of launching their issues at a time of market volatility.

"Obviously, it impacts their cost of funds," said the sellside source.

"They are issuing at a spread over Treasuries. In absolute terms, it's going to affect them. But they are not exactly related to monetary policy in the U.S.

"It affects all issuers on the dollar market and it will go to the euro market, which is having a little bit of supply."

On Monday, the Bolivarian Republic of Venezuela priced €1 billion of 10-year bonds (B2/B/B+) at 99.301 to yield 7.10% via Deutsche Bank Securities and UBS Investment Bank.

"And now there are rumors of them planning to do a dollar deal," remarked the sellside source.

In trading Wednesday, Venezuela bond due 2027 dropped two points to 103½ bid.

Argentina up in gray market

In separate news, there are reports that Argentina's new bonds are trading up in the gray market, said the sellside source.

Argentina snagged 76% of bondholders to take part in its restructuring of $102.6 billion of defaulted debt. The new bonds will be free to trade on April 1.

"It's still going to be difficult for them to get a clear view for the rest of the month," said the sellside source.

"Basically, the story is that they are trading up because of the optimism of the exchange.

"We will have to see what the IMF and official participants say about the results, which some of them have not come forward yet."

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