Emerging market debt rides high on U.S. CPI numbers; "beyond a relief rally"

By Reshmi Basu and Paul A. Harris

New York, June 15 - Emerging market debt perked up on news that May's core inflation was in check in the United States, signaling to investors that an impending Federal Reserve rate hike will be measured.

"People are buying," said a trader. "Treasuries have rallied like crazy. Everybody's feeling good."

In primary action, Malaysia's Public Bank Bhd priced $350 million of 10-year subordinated notes (Baa1/BBB+) at 99.716 to yield 160 basis points over U.S. Treasuries

The deal came at the tight end of guidance which had put the spread at 160 to 165 basis points.

Barclays Capital and Citigroup were bookrunners for the Regulation S deal.

The release of U.S. consumer price index included the news that core inflation increased a mild 0.2%, as expected - even though overall consumer prices rose at their fastest pace since January 2001.

In response, emerging markets debt rallied as inflation appears to be contained or at least manageable.

"The market is ecstatic about these CPI numbers," said an emerging market analyst.

"A lot of investors feared that the core rate would be higher than expected, which could potentially force the Fed to move 50 bps at its next meeting and signal more steep increases from there.

"Instead, the core rate is only 0.2%, well under control, so the Fed can be more gradual.

"That's an excellent scenario for EM - higher rates will still take their toll but the market was most worried about a faster than expected rise in rates," he added.

Demand for Latin American paper firmed up with Brazil, Venezuela and Mexico leading the way.

The Brazil C bond was up about 1¾ point Tuesday to 90¼ bid in late trading. The bond due 2040 was up 2½ points to 91 bid, 92 offered.

Mexico also firmed up. Its bond due 2016 was up 2¼ points to 138½ bid. The bond due 2026 was up a quarter of a point to 138¼ bid.

Venezuela also rose. The bond due 2027 was up 1½ points to 84½ bid. The bond due 2034 was up a point to 83½ bid.

Rally beyond relief

"It was even beyond a relief rally," said Enrique Alvarez, Latin American debt strategist for research firm IDEAglobal.

"The gains have been quite substantial, particularly high beta credits. Brazil has led the way for most of the day.

The low core CPI number gives the market some breathing room since investors have seen most of the major U.S. economic data ahead of the Federal Open Market Committee on June 29-30, according to Alvarez.

"Essentially people are taking for granted that the Fed goes with a quarter point hike at the end of June," he explained.

Also Tuesday, Federal Reserve Chairman Alan Greenspan repeated that interest rate hikes would be measured at his re-nomination meeting in front of the Senate Banking Committee.

"Our general view is that inflationary pressures are not likely to be a serious concern in the period ahead,'" Greenspan said.

He added that rate hikes were "very likely to be measured over the quarters ahead."

However, the low core CPI number may not be enough to bring back large numbers of issuers.

"Prices have just gone up," said IDEAglobal's Alvarez. "Spreads have not tightened significantly, which would be a better indication of the moment when issuers will come in and attempt to do something," he added.

Brazil's inflationary pressures

A market source said that in response to the U.S. Consumer Price Index news and the subsequent rally in the 10-year Treasury note the Brazilian real gained 1.4% to 3.1232 to the dollar by the afternoon, up from 3.1665 late Monday.

However, the source said, the Brazilian central bank, which has cut interest rates nine times since last June to 16% from 26.5% may come under pressure to tighten policy in the intermediate term as inflationary forces exert themselves upon the Brazilian economy.

At the beginning of this week, the source said, skirmishing began in earnest in the Brazilian senate over the Lula government's provisional measure raising the minimum wage. Some speculate that the vote will be postponed, although the most likely scenario is that the vote will be held in the next few days and that the result will go the government's way, the source said.

Also, after having stalled for as long as it could, Petrobras announced that gasoline refinery prices would be raised by 10.8% and diesel refinery prices by 10.6%.

Brazilian consumers can expect to take an approximately 4.5% hit for gasoline and 6.4% for diesel as a result of the first increase in fuel prices announced by Petrobras under the Lula government.

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