Emerging market debt eases on weak equities

By Reshmi Basu and Paul A. Harris

New York, Aug. 23 - Emerging market debt slipped Wednesday in light trading, tracking U.S. equities lower on the back of surprisingly weak housing data.

Earlier in the day, U.S. stocks rose as oil prices slipped, but then those gains were erased following a report on existing home sales, which showed that sales for the month of July had plummeted to a two-year low.

That raised fears that the U.S. economy may head into a recession, triggering losses across major U.S. equity benchmark indexes. At session's end, the Dow Jones Industrial Average index was down 41.94 to 11,297.90.

Meanwhile U.S. Treasuries were little changed with the yield on the 10-year note at 4.81%.

Against the unsupportive backdrop, emerging market debt posted losses in trading, according to a market source.

The prior session had begun to see the unraveling of U.S. stocks on hawkish comments by Federal Reserve Bank of Chicago president Michael Moskow, who warned that the central bank may resume monetary tightening to combat inflation. That created a less benign environment on Tuesday. However, emerging market debt was virtually unchanged on a dollar and spread basis in the absence of any emerging market-specific catalysts to push the asset class one way or another. Some credits, such as Argentina and Ecuador, fell victims to profit-taking while Mexico outperformed the market.

But on Wednesday, very few sovereigns were spared as most credits saw lower dollar prices. However, since liquidity is dismally low, price action is exaggerated, according to a market source.

"Volumes are barely there," noted a trader. "Latam was lower on the day. Everything was down," he added.

During the session, the bellwether Brazilian bond due 2040 shed 0.65 to 129.60 bid, 129.65 offered. The Argentinean discount bond due 2033 lost 1.15 to 96.40 bid, 96.60 offered. The Colombian bond due 2033 gave up 1.50 to 134.75 bid, 136 offered. The Venezuelan bond due 2027 eased 0.85 to 123.20 bid, 123.65 offered.

Elsewhere, the Russian bond due 2030 lost 0.44 to 110.50 bid, 110.875 offered. The Turkish bond due 2030 was down 1.50 to 148 bid, 148.50 offered.

Nonetheless, prices may have been lower Wednesday, but that does not mean that anyone should draw any meaningful conclusions from the session's performance. The asset class' resilience will not be tested until after the Labor Day holiday in the United States when liquidity begins to increase, noted an analyst.

Additionally, a continued Fed pause and modest weakness in the U.S. economy, particularly in the housing sector, should support a positive bias for emerging markets, according to another analyst.

The central bank will likely resume raising the fed funds rate in December, but until the overall market shares in that view, emerging markets will trade fairly well.

The clincher is that with spreads so tight, there is little upside for the market. In the last two weeks, spreads for the JP Morgan EMBI Global index have been trading in a range of 190 basis points.

Thus local markets will be the recipients of the market's overall benign environment, as the diminished liquidity will boost the carry trade in local instruments.

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