Emerging market debt falls with Treasuries drop; Argentina up on expectations of a juicier deal

By Reshmi Basu and Paul A. Harris

New York, Oct. 1 - The slide in the U.S. Treasuries market drove down emerging market debt but Argentina rode high as the market expects a sweeter restructuring deal.

"It was hectic morning," said a trader. But he added that trading calmed down by 12:30 p.m. ET, which is typical for Friday.

"There was a sell-off when the Treasuries took a dive," said a second trader.

U.S. Treasuries unraveled Friday as the market interpreted a mixed bag of data as further evidence that the Fed would increase rates at its November meeting. The Institute for Supply Management's manufacturing index fell to 58.5 in September from 59.0 in August, falling below market consensus.

But sales for North American-made vehicles came in at a 14.8 million annual rate, landing much higher than the expected 13.5 million.

The yield on the 10-year Treasury rose to 4.18% from 4.12% on Thursday.

"With equities bouncing back, the risk environment has somewhat improved," said the buyside source.

"At the same time, Treasuries have dipped and that's good for growth, which is also good for EM.

"We definitely had some tightening today, and I'm looking at prices in general, and they look like they are down, but we're only down a fraction of what Treasuries are down," he noted.

During Friday's session the Mexico bond due 2008 fell 0.45 to 114.10 bid. Its bond due 2016 dropped 1¼ to 145 bid while the bond due 2026 lost 1½ to 2026.

Russia's bond due 2030 slid 0.063 to 96.187. The Brazil C bond lost 0.062 to 98 7/8 bid while the bond due 2040 fell 0.35 to 111.85.

Overall, the JP Morgan EMBI+ Index fell 0.11% by late afternoon but its spread tightened five basis points.

After holding its own against three straight days of sliding Treasuries, emerging market debt finally succumbed, but ever so slightly.

"You can only [hold] for so long," commented the buyside source.

"When the risk environment is positive and you're having good news, you can continue to tighten, but there's a limit on how much you can tighten."

"We've had so much action this week with all the new deals...it was a catch-a-breath kind of day," he added.

Market seen healthy

But the fact that the market has been able to soak up the new supply means that the market is healthy, according to the first trader.

"With $17 billion of new issuances this month, the market has absorbed it," the trader said.

The $17 billion total of new deals was circulating in the market, although Prospect News' data shows issuers priced $18.5 billion of paper in the international markets in September.

"There's been a lot of liquidity," said a Latin American strategist at Refco EM.

"And I think the market is capable of absorbing new issues from corporates next week."

He added that the environment is a little bit different than what was experienced in May, when the market could not handle the new supply amid interest rate fears.

Venezuela, Turkey up in secondary

Furthermore, this week's new issues from Turkey and Venezuela continued to perform well in the secondary market.

On Thursday, the Republic of Turkey surprised the market with an offering of $1 billion of bonds due 2015 (B1/BB-), priced at 98.573 to yield 7.45%.

During Friday's session, the new 2015 traded at 99 bid, 99¼ offered.

On Wednesday, Venezuela priced a $1.5 billion global due 2014 at 95.056 to yield Treasuries plus 520 basis points. The Latin American country issued $710 million in an exchange for Brady bonds while the remaining $790 million was sold to investors for cash.

During Thursday's session, the bond due 2014 was trading at 97.40 or 473 basis points over the 10-year Treasury.

And the new issue continued to aim higher, according to the first trader, trading at 98¼ or 462 basis points over Treasuries on Friday.

Barclays Capital and Merrill Lynch & Co. were lead managers.

Argentina rises

On Thursday, the Securities and Exchange Commission gave the green light to Argentina to proceed with its proposal to reschedule payments.

In June, Argentina offered to pay 25 cents per dollar of its $100 billion defaulted debt.

But its paper has been climbing as the market anticipates a sweeter deal.

"The market seems to think that there is going to be an improvement of five to seven cents - 30 cents to 32 cents," said the Refco strategist.

"That is what is driving the market."

The Argentina bond due 2008 added ¾ to 31 bid.

"You're still expecting to get 40 cents of net value. The market has a more optimistic scenario that what they are offering," noted the buyside source.

"I don't understand it. It's kind of weird because you have that court ruling this week in favor of creditors, and at the same time the SEC moves ahead."

Harold Baer, a New York judge, issued a ruling that temporarily froze a $250 million debt-restructuring proposal by the government of Mendoza, a province in western Argentina. Some have said that this proves that litigation is a powerful tool and that bondholders do not have to submit to Argentina's proposal.

Dominican Republic

Also among troubled issues, on Thursday, a group of holders of the Dominican Republic's dollar-denominated bonds said they had formed a committee to mobilize bondholders in the wake of current events, according to a news statement released by its legal counsel Bingham McCutchen LLP.

"They haven't defaulted yet. They have the capacity to pay," said the buyside source.

"They probably have to do something. It doesn't seem to be a contentious event."

In April, the Paris Club said it reached an agreement with the government of the Dominican Republic to restructure $155 million of debt maturing from Jan. 1, 2004 to Dec. 31, 2004 and $38 million of arrears.

Under the agreement, payments due to Paris Club creditors in 2004 would be cut to $293 million from $479 million. The Dominican Republic would repay its debt over 12 years with a five-year grace period.

A few bondholders formed the committee to protect its interests, as there has been mounting concern over comments made by Dominican Republic president Leonel Fernandez Reyna regarding public bonds.

"Paris Club requires comparability. They agreed to defer their interests and amortizations. And by comparability, that also means that the public debt should also have the same burden," said the buyside source.

Past indications have suggested that if the country does a swap, expectations are that it would not be at net present value - a negative for bondholders.

"This is not Argentina. The bottom line is that the Dominican is still a relatively low debt country, despite piling on a lot of debt in the last two years."

The buyside source added it is more a liquidity issue than a solvency issue.

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