Eastern European pipeline seen despite Russia-Georgia tensions; EMBI 6 bps wider as Treasuries rally

By Paul A. Harris

St. Louis, Aug. 25 - Emerging markets eased against Treasuries in trading Monday - but sources said the underperformance was mainly due to a rallying U.S. government market rather than any activity in emerging markets.

With the typical end-of-summer lull exacerbated by a bank holiday weekend in the United Kingdom, Monday's emerging markets session was a dead quiet one, sources said.

An emerging markets syndicate official expects no news until mid-to-late in the first week of September, following the three-day Labor Day weekend in the United States.

"Liquidity is very weak," the official remarked.

Late in the day a market source spotted the EMBI Global Diversified index at a 330 bps spread to Treasuries, 6 bps wider on the day.

However the source chalked up that widening to rallying U.S. Treasuries, which yielded 3.79% late Monday, 8 bps lower than Friday's close.

The Brazil 11% bonds due August 2040, considered to be the most liquid instrument of the emerging markets asset class, were unchanged at 131.90 bid, 132.05 offered, according to Enrique Alvarez, head of Latin American debt strategy for the financial research firm IDEAglobal.

"It's very quiet in general," Alvarez noted.

"Latin America is not exhibiting the jitters that are visible in U.S. equities," the strategist added, noting that the Monday session was unfolding against big drops in the U.S. stock indexes, with both the Dow and the Nasdaq falling more than 2%.

"There is no risk aversion selling that I can detect in emerging markets," Alvarez said.

"There is just a touch of softness in the high-beta credits which, in recent weeks, has sort of been a trait of the category: when you see a loosening on the equity side there seems to be some pass-through into the high-beta Latin sector. But it's very moderate."

For example, Alvarez said Venezuela's 9¼% notes due September 2027, one of the more liquid high-beta bonds from Latin America, were trading in a context of 90½ bid, 92 offered, on Monday, ½ point lower on the bid side.

"The 1½ point bid-offer spread indicates very illiquid conditions symptomatic of the late summer period," the strategist commented.

Eastern Europe deals seen in September

Meanwhile an emerging markets syndicate official told Prospect News that there is definitely a September pipeline.

"Most of it tends to be eastern European names," the official said.

"Latin America still lags on the new issue front. Overall they have not been forced into tapping this market.

"However the east Europeans have," the source continued.

"They have been willing to pay the higher spreads and new issue premiums that Latin America has not been willing to pay. So there has been a disconnect."

Prior to the outbreak of fighting in Georgia, the source said, issuers from eastern Europe demonstrated a willingness to pay new issue premiums of 35 to 50 bps, or more.

As examples the official pointed to OAO Severstal, issuing via Steel Capital SA, which priced $1.25 billion senior loan participation notes July 29, 2013 at par to yield 9¾%, on July 22, and Russia's Evraz Group SA which raised $404.6 million of proceeds by tapping two of its existing issues in May: a $250 million add-on to its 8 7/8% notes due April 24, 2013 at 101.15 to yield 8.579% and a $150 million add-on to its 9½% notes due April 24, 2018 at 101.15 to yield 9.371%.

However, the syndicate official added, these issues have tended to trade well in the secondary market.

Factoring tensions in Georgia

Prospect News asked this official if the recent armed conflict in the Republic of Georgia could complicate potential issuance from the East European/Commonwealth of Independent States sector.

In early August the Republic of Georgia engaged in skirmishes with militias in the separatist regions of South Ossetia and Abkhazia. Subsequently Russian Federation forces attacked Georgian units in South Ossetia and then moved into mainland Georgia.

In the interim there have been disputed reports of pullbacks on the part of the Russians. However tensions reportedly remain high.

The syndicate official said that the situation in Georgia will be the big question once the markets start to open up again.

"No one has attempted to come since the Russian and Georgian situation came to light," the official said.

"But there will be some roadshows in September, and it will be interesting to hear the feedback from investors as to what sort of premium they will expect from a CIS or Russian corporate."

Meanwhile IDEAglobal strategist Alvarez said that it is difficult, in the wake of armed conflict in Georgia, to say whether Latin America is outperforming Eastern Europe because there are very few representative credits out of Eastern Europe that are still traded with any degree of liquidity.

"Russian debt instruments are not playing this game of higher political risk that is affecting other markets," Alvarez remarked adding that he does not detect a marked consequence of the "political situation" in Georgia within debt prices.

15% to 16% cash

Meanwhile the emerging markets syndicate official reported hearing that the cash positions of dedicated emerging markets accounts are perceived to be as high as high as 15% to 16%.

"Talking to both the accounts and the sales force this morning, people were saying that there needs to be some sort of resolution to the Fannie Mae and Freddie Mac situations, as well as the situation with Lehman Brothers," the official said, referring to reports that the mortgage lenders would have to be bailed out by the government, and that Lehman Brothers, also suffering in part from its exposure to mortgages, is now a takeover target.

"If those situations are dealt with appropriately there is quite a bit of cash on the sidelines," the syndicate source said.

"But no one expects any sort of announcement on Fannie and Freddie this week.

"That's going to keep people on the sidelines."

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