Emerging market debt edges higher with Treasuries; Venezuela's up, Russia way up

By Reshmi Basu and Paul A. Harris

New York, May 17 - After a rough morning, emerging market debt traded higher Monday as a rally in U.S. Treasuries prompted investors to make bids in Latin America.

"They're up because Treasuries are higher," said a buy-side source. "We started off the day, high yield was doing better and EM was softer."

"Then we saw it converge," added the source.

Geopolitical risk intensified with Monday's assassination of the head of Iraq's governing council, giving a lift to U.S. Treasuries.

"While off to a shaky start, we are seeing better buyers all morning with bonds trading up in virtually all countries," said a secondary market source.

"Local bonds in Mexico, Colombia and Argentina are better bid as well. Looks like there is follow through from real accounts.

"This weekend's Barron's ran an article on EM debt quoting both Fuss from Loomis and El-Erian from Pimco. Absent more aggressive data for the U.S. Treasury market we seem to have bottomed out," said the market source.

Some believed that Friday's U.S. consumer price index numbers also served as a catalyst to bring investors back into the buying mode. However, others contend that the numbers provided little new information and the market could slide further.

"I think what's been driving EM has been risk aversion," said the buy-side source. "Those numbers have not changed anything about the Fed raising rates.

"We still have a couple of innings in this game to play. But definitely the Fed is going to tighten. And that's a negative, all things being equal for EM.

"Now, EM has definitely sold off much faster and quicker than other risky assets. Maybe that can help it.

"I didn't buy anything off of those numbers," added the buy-side source.

"We've been adding. It's more because the relative value has shifted somewhat, not because we think the sell-off is necessarily over.

"You look at how these things are historically, the market can go a lot lower."

The JP Morgan EMBI Index rose 0.24% during Monday's session. Its spread to Treasuries tightened by two basis points to 496 basis points.

Meanwhile Latin American countries that had been beaten up in early May continued to outperform on Monday.

"Ecuador, Columbia and Peru got beat up bad at the beginning of this month," said the buy-side source. "They are all outperforming in the last few days."

Spreads for all three countries narrowed by double digits Monday. The Peru component of the EMBI tightened by 32 basis points to 428 basis points.

Oil lifts Russia, Venezuela

The rising price of oil continued to be a boon to oil-producing countries such as Russia. And the high costs may even shield some countries from the impact of expected interest rate hikes and political instability.

The Russian component of the EMBI index rose 1.12%. Its spread to Treasuries tightened by 11 basis points to 307 basis points.

"It's been a home run for Venezuela - $40 oil can offset a lot of political risk," said an emerging market analyst.

"The thought is that neither Venezuela nor Ecuador has to tap the market this year - although Venezuela's domestic issuance does add some supply pressures - so they are relatively immune to pressures from higher interest rates.

"Oil prices above $40 per barrel mean that there will be no fiscal or balance of payments problems in either of these countries this year," said the analyst.

Dominican Republic gains on election

And Wall Street lauded the return of former president Leonel Fernandez to office in the Dominican Republic.

Spreads on the Dominican Republic's debt tightened by nine basis points to 1,252 basis points.

Fernandez campaigned on a platform to cut government spending and renegotiate much of the country's $7.6 billion debt.

Brazil loses

While some other Latin American were benefiting from higher oil prices, Brazil fell as political risk scared away investors.

By mid-day, the Brazil bond due 2013 was down 0.677.

The benchmark C bond was down 0.13 at 88.875 bid, 88.938 offered while the bond due 2040 was down 0.25 at 87¾ bid, 88½ offered during Monday's session.

With regard to Brazilian debt, another buy-side source told Prospect News on Monday that Santander's chief economist in Sao Paulo, Andre Loes, has identified international and domestic factors at play.

"First, President Lula's honeymoon with local business leaders has come decidedly to a halt on the back of serial political miscalculations and miscues, starting with the so-called 'Waldomiro' case in February and most lately including unsatisfactory setting of the minimum wage, which seems to have left no one satisfied," Loes wrote in a recent report.

Loes added that Brazilian corporations are becoming more risk averse at least in part because of increased political uncertainty in Brasilia.

Loes also cited uncertainty about the path of U.S. monetary tightening and the increased perception that the moment for a rate hike is nearly at hand, much sooner than has been anticipated as recently as one month ago. He also cited rises in dollar-denominated commodity prices that are dimming the prospects for sharp falls in Brazilian inflation.

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