Brazil drags down emerging market debt; South Africa's deal preparations continue

By Reshmi Basu and Paul A. Harris

New York, May 20 - Taking a cue from Brazil, emerging market debt slid after the South American nation's Central Bank decided to keep interest rates unchanged.

"The markets are taking the COPOM decision badly today, especially after the weak balance of payments data that came out this morning," said an emerging market analyst.

Brazil itself was slammed during Thursday's session. Its benchmark C bond slid 1.13 to 87.125 bid, 87.437 offered while the bond due 2040 fell 1.40 bid at 86.20, 86.25.

The Brazilian component of the EMBI Index was down 0.94%. Its spread to Treasuries widened by 20 basis points to 509 basis points.

"The COPOM decision proves what everybody feared: the Central Bank cannot cut rates so long as external conditions are weak," said the analyst.

"The Central Bank is in a lose-lose situation: if they had cut rates yesterday [Wednesday], they would have been recklessly cutting rates when the market was demanding higher rates.

"But by keeping rates steady they show that the economy will not grow as much as expected, which has investors panicked.

"And Lula needs rates to keep coming down in order to deflect criticism over his economic policies; with rates not being cut, Lula stands to lose even more political capital," added the analyst.

Not the start of another plunge

However, the downturn in Brazil is not a harbinger of another frenzied sell-off.

"Tuesday wasn't too bad. Wednesday morning the market was actually higher. It turned lower Wednesday afternoon, along with equities," said a sell-side official.

"Even though today Brazil is down three points, I think in general people seem less stressed out by these market moves than they seemed by the ones that happened two weeks ago," added the sell-side official.

"We're not hitting the lows that we hit then. At the end of last week the Brazil 2040 bonds had an 84 handle. So right now it's better than what it has recently been."

"The price moves are still pretty severe. But they don't seem to be upsetting people as much."

Brazil's component of the JP Morgan index fell 0.94% during Thursday's session. Its spread to Treasuries widened 20 basis points to 509 basis points.

Meanwhile in the late afternoon trading, Brazilian corporates recovered after trading down in early morning,

"I guess the market doesn't think there's a real crisis right now. A lot of people thought that Brazil was going to get downgraded or something, but if that was the case it should be trading lower," said another analyst. "The trading is flat."

Investors seen cutting duration

Generally investors in the past week and a half are more defensive, according to a debt strategist at Refco EM.

"They are reducing duration. They are looking for value within the short part of the curve," said the strategist.

"And also they are favoring countries that are to benefit from the high price of oil.

"Among these countries, we've seen some interest in Russia, Venezuela, Mexico and to a minor extent Ecuador," he added.

Also there has been interest in paper from countries that do not need external financing.

South Africa's

South Africa's planned bond offering is expected to be somewhere between $750 million and $1 billion of a seven- to 12-year issue, according to the sell-side official.

While South Africa has been on the road, the country is going to have to spice up the deal to whet investors' appetites.

"Investment-grade issuers are certainly going to have to pay wider spreads today than they would have a month ago," said the sell-side official.

"So the question will be whether or not those guys want to pay up or wait.

"If you wait you might get tighter spreads later on but higher Treasury yields. So it's a bit of a trade-off.

"The investor meetings are happening now. If the market looks good next week there is a good chance that will put a deal into the market.

"But they may very well decide to wait.

"They are an infrequent issuer. So they're very sensitive to the how strong the market appears to be," added the sell-side source.

Barclays Capital and JP Morgan are running the books.

S&P raises Kazakhstan

Meanwhile Standard and Poor's upgrade of Kazakhstan has helped its debt.

The rating agency raised the republic's long-term foreign currency ratings to BBB- from BB+ citing the sustained strengthening of its economic prospects, as well as prudent policies keeping the government's deficit and debt at low levels. The outlook is stable.

"That helped Russia, which turned around a little on the back of that," said the sell-side official.

The Russian bond due 2030 was up half a point at 90.125 bid.

The Russian component of the EMBI rose 0.22%. Its spread to Treasuries widened by five basis points to 305 basis points.

In the primary, Korea Development Bank is talking about a Samurai issue - "which is a little different," said the sell-side official.

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