Emerging market debt spreads narrow ahead of Fed; Brazil sells R$3.4 billion of bonds due 2016

By Reshmi Basu and Paul A. Harris

New York, Sept. 19 - Emerging market debt was at a virtual standstill Monday as investors chose to remain on the sidelines a day ahead of the Federal Open Market Committee meeting.

Meanwhile, the headlining story of the day belonged to the Republic of Brazil. For the first time, Brazil issued a local-currency denominated sovereign issue in the international market.

The new issue did well and saw heavy demand, according to market sources.

Brazil placed R$3.4 billion - or $1.479 billion equivalent - of global bonds due Jan. 2016 at 98.636 to yield 12¾%.

JP Morgan and Goldman Sachs were joint bookrunners. Banco Itau acted a co-manager.

The search for yield was a leading factor as to why one buyside source decided to play in the deal.

"Brazil is just following a series of similar deals," noted the source.

"And I think local markets are the next sector within our asset class that's going to take everyone's attention.

"And with taxation and all these regulations that are very prohibitive for foreign investors in accessing local markets, I think an instrument like this, which is euroclearable...is a welcome instrument by everyone," added the buyside source.

Furthermore, the source added that the lingering Brazilian political scandal did little to distract investors from the new issue.

"What drives most of the demand for local currency paper in Brazil is the fact that the easing cycle has begun. The central bank has started cutting interest rates... so that's good for the local markets.

"Hoping for not a lot of volatility in the currency market, this is going to be a great carry trade," she remarked.

EM sees positive tone

During the session, spreads were slightly tighter in thin trading, said market sources.

U.S. Treasuries traded in tight ranges Monday, which translated into a positive session for emerging markets, said a market source.

"We had a better tone. We tightened a little bit today [Monday]," said the buyside source.

The best performers of the day were Colombia and Venezuela, according to the market source.

Colombia's portion of the JP Morgan EMBI Global index tightened seven basis points while Venezuela narrowed by 12 basis points.

Colombia benefited as last week's buyback was increased by $432.5 million. The source said the total now stands at $1.13 billion. Meanwhile higher oil prices boosted Venezuelan paper.

Brazil's portion of the EMBI index tightened five basis points.

FOMC seen hiking hike rates

The buyside source added that Tuesday's FOMC meeting is of little concern to investors, as the market is expecting a 25 basis point rate hike.

"No one is expecting any punches,' said a trader, who added that investors were "playing it safe" on Monday.

Looking ahead, the buyside source does expect the central bank to pause its monetary tightening campaign.

"My personal opinion is that there should be one [pause] if oil prices continue at these high levels.

"I think the Fed will have to pause, even if it is just to figure out what to do next - not necessarily because they have to do it but they have to see what the impact on the economy is," noted the source.

"If they raise it too fast, the risk of recession is quite high."

But the source remains positive on the asset class, even if the United States was to enter a new environment of slower growth and higher inflation.

"I think we're playing it from the point of view that we are fine till year-end. Next year, you are going to have volatility anyway from elections in Latin America," the source added.

"As long as [U.S] interest rates stay low, that's good for EM."

"I think a lot of countries have been able to gear their economies toward domestic demand," observed the source.

While a slowdown in the United States is still a negative, emerging markets are better equipped now to deal with it than they were five years ago.

"As long as these countries are going to grow from within, and with interest rates low in the U.S., I think the search for yield is still going to be there," remarked the buyside source.

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