Emerging market debt cashes in on lower-than-expected job numbers; Brazil's long maturities up

By Reshmi Basu and Paul A. Harris

New York, Feb. 4 - Emerging market debt soared Friday on a rally in U.S. Treasuries ignited by soft employment data in the United States.

The roar in U.S. Treasuries helped emerging markets score big gains in trading. The JP Morgan EMBI+ Index surged 0.76% while its spread to Treasuries narrowed six basis points to 359 basis points.

The U.S. Labor department reported that non-farm payrolls rose by a mere 146,000 in January. Additionally, December payrolls were revised downward to 133,000 from 157,000.

"Trading was pretty volatile," said a trader. "After the number came in less than expected, we just followed Treasuries. Treasuries skyrocketed. Brazil followed right behind it, staying right with Treasuries - tightening on the day."

The yield on the 10-year note fell to a three-month low of 4.07% from Thursday's 4.17%.

The Brazil C bond added 3/8 of a point to 102 5/8 bid while the bond due 2040 gained 2.40 points to 117.70 bid.

Brazil's long end up

The long end of the Brazilian yield curve basked in the afterglow of Treasuries rally. The bond due 2020 was up 2¼ points to 133 bid. The bond due 2030 gained two points to 130 bid. The 2027 bond and the 2034 bond each saw a two point gain.

The Russia bond due 2040 added ¾ point to 106 bid. The Venezuela bond due 2027 was up 0.85 to 103 bid.

Meanwhile the Argentine debt swap had its first deadline Friday for retail investors to get on board for the par bonds, one of three bonds in the exchange. Official participation rates will be released on Monday.

The Argentina bond due 2008 gained 0.10 to 31.10 bid,

Who's buying Treasuries?

While the weak job numbers lifted U.S. Treasuries after a four-day lull, one investor was left bewildered, trying to figure out who is soaking up those bonds.

"Taking the long view, I just don't understand who is buying 10-year Treasuries at 4.05%," said Steve M. Hope, managing partner of Outrider Management.

"You have to love the Fed and hate the economy. You have to believe that the Federal Reserve has totally conquered inflation and has it under control for the foreseeable future and believe that real GDP growth for the U.S. economy in the next 10-years will be below 2-3 %," he said.

Hope is amazed that there is enough interest in the 10-year note at 4.05%.

"I would believe it is hedge funds if you told me. One thing that I was looking at this morning was trying to figure out if foreign central banks are big players that far out the curve.

"Everybody talks about their participation in the Treasury market. It would have surprised me to find out if they were involved out past a year because they would have no reason to be," he told Prospect News.

On Thursday, the JP Morgan EMBI was at an all-time high, according to Hope.

"In the month of January, it returned about half of its coupons, so there might have been a little bit of a price decline in January.

"There's been obviously a fantastic price increase in the first week of February. Brazil '40s are trading at 1171/2. They closed December at 118½ - and that was pretty close to the price high. If we are not there, we can see it from here - the all-time highs on the bond prices," he added.

Nonetheless, the greatest risk to emerging markets is how movements in the Treasury curve unfold, he added.

Outrider's Hope holds a short duration in Brazil. In the last week, he added shorts to Colombia and Ecuador.

"It's more of a portfolio hedge than hating Brazil. There seems like there is less and less risk associated with being short in things at 8% or 9%.

"The downside is that the threat of further spread compression or a Treasury rally seems pretty low to me," Hope remarked.

Hope added shorts to Colombia and Ecuador because of the technical aspects of the bonds as well as his view that the countries are vulnerable fiscally.

In regards to spread and macro-variable terms, Colombia doesn't look too different from Brazil.

"It's probably weaker than Brazil politically, but less liquid. You pay more to do the trade in Colombia. Colombia is more volatile but also has the relationship with the U.S., which makes it more reliable from that standpoint," he commented.

Additionally, there are not too many bad seeds in the emerging market universe, with the exception of Venezuela. Most countries have taken positive steps to make themselves better credits.

"Venezuela has probably taken negative steps to make themselves a worse credit, but it's been buoyed by oil prices," said Hope.

Looking ahead, Hope is focusing on Treasuries and inflation indicators in the United States. He is operating under the assumption that the Fed will be tightening every meeting for the rest of the year.

"And in that context, can yields on the longer bonds stay where they are? I don't think they should.

"From a macro standpoint, I am much more focused on Treasuries than relative to individual credit quality of nations than I ever have been because spreads are so tight." He noted.

And like most investors, Hope said it has been difficult to find good deals with good yields in the market, something he expects to carry into the next year and maybe longer.

Nonetheless, the market has absorbed recent wave of new issuance. And more should come, given how low rates are.

"If you aren't thinking about issuing right now, you are crazy. If you have a financing gap to cover in 2005, you should be polishing up your presentation to investors right now," commented Outrider's Hope.

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