Emerging market debt higher on increased investor appetite; Brazil offers to swap $1.5 billion in bonds

By Reshmi Basu and Paul A. Harris

New York, July 27 - Emerging market debt continued to post gains Thursday, building on the momentum seen in previous sessions.

In other news, the Federative Republic of Brazil announced Thursday that it would swap up to $1.5 billion in existing dollar-denominated bonds with maturities ranging from 2020 to 2040 for additional debt added on to its existing bonds due 2037.

The move is intended to improve the country's debt profile by extending duration and erasing higher yielding issues, but sources noted that few investors would find the deal particularly fetching.

"I don't find the swap to be overly attractive," remarked Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal.

After all, there is not much incentive for holders to take a lower paying bond in lieu of their current Brazilian holdings, whose coupons range from 8 7/8% to 12¾%. The 2037 bond bears a 7 1/8% coupon.

"They are not actual bonds that are soon to mature. These are actually pretty long-term issues," explained Alvarez.

"I find it a difficult issue to convince oneself to participate."

News of the buyback had a mild impact on the Brazilian curve, remarked sources.

Short covering propping market

Instead, the sovereign's debt jumped on the ongoing momentum, triggered by the realignment of portfolios during the market's recent spread tightening.

"There's a lot of market talk making the rounds that the hedge funds were overly short and that they had to cover over the course of the last week, week and a half," said Alvarez, noting that the covering by hedge funds was most likely an instantaneous move.

Additionally, the market is expecting that outflows into the asset class will diminish, which is helping build up investors' appetite for risk, observed Alvarez.

Funds lose $89 million

Emerging market dedicated funds saw $89 million leave the asset class for the week ending July 26, according to EmergingPortfoliio.com Fund Research.

Ten out of the last 11 weeks have seen outflows. However, this week's loss is substantially lower than last week, which saw $206 million exit the market. And some investors are hedging their bets that the risk aversion mode, which was visited in May and June, is coming to somewhat of a close.

Reallocation of cash

Furthermore, there appear to be more trades recently in off-the-run names. There was decent interest on the back of this week's new supply from Panama and Uruguay.

On Tuesday, Panama priced a $313 million add-on to its sovereign bonds due March 15, 2015 (Ba1/BB/BB+). The previous day, Uruguay reopened its 8% bonds due 2022 (B3/B/B+) to add $500 million in a drive-by.

And this can be interpreted as a sign that investors are moving away from the sidelines and reallocating their high cash balances, according to an emerging market analyst.

"I think the Panama and Uruguay definitely show that accounts have plenty of cash on hand, even after all of the outflows that EM investors have seen since mid-May," according to the analyst.

"Coupons, amortizations, and buybacks have put a lot more cash into investors' hands than has left EM funds in redemptions, so that has built up a cash hoard in a number of accounts.

"Panama and Uruguay may be off the run, but they are decent sovereign new issues, and there's been very little of those in recent weeks," he added.

August will see $3.4 billion in coupon and amortization payments while sovereigns' financing needs remain light. Alvarez said that in anticipation of that windfall, investors are putting cash back to work.

Nonetheless, he warned that there is not an overly large interest in the market.

"I don't think the crossover players, the pension funds in the U.S. are going to look at the market that positively until we have more clarity as risk tolerance is concerned," he said, in reference to such factors as the Middle East tension and crude oil price volatility.

EM bonds higher

Overall, emerging market debt saw investors' appetite for risk crank higher.

Spreads were tighter by four basis points, according to a trader, who added that Turkey was one of the outperformers of the day.

During the session, the Turkish bond due 2030 added 0.88 to 144.625 bid, 145.125 offered. The Russian bond due 2030 inched up 0.38 to 108.50 bid, 108.875 offered.

Elsewhere, the bonds that Brazil offered to buy back were higher in trading.

During the session, the bond due 2020 gained 1.50 to 148 bid, 149 offered. The bond due 2024 added 1.50 to 116.50 bid, 117.50 offered while the bond due 2024, series B jumped 2.50 to 116.50 bid, 117.50 offered. The bond due 2027 was up 1 point to 130 bid, 131 offered. And the 2030 bond rose 2 points to 154 bid, 155 offered.

Meanwhile the 2037 bond was also up 0.75 to 98.15 bid, 99 offered. The bellwether bond due 2040 lost 0.15 to 128 bid, 128.05 offered.

In other news, Standard & Poor's lifted China's long-term sovereign credit rating to A from A-.

During the session, the Chinese bond due 2008 was down 0.03 to 104.032 bid, 104.145 offered while the bond due 2011 was up 0.02 to 104.80 bid, 105.018 offered.

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