Emerging market debt bounces back; Moody's better outlook for Brazil helps tone

By Reshmi Basu and Paul A. Harris

New York, Jan. 12 -Emerging market debt regained ground early on Wednesday as a ratings change for Brazil helped push the market forward.

Moody's raised Brazil's debt rating outlook to positive from stable, saying that rising exports are helping the country pay off foreign debts.

The news, on its own, did not push prices higher, but added to the overall positive sentiment during Wednesday's session, according to a market source. The market was ready to edge higher, after Tuesday's stronger finish compared to recent sessions, he said.

"The market was already up during the course of the day today [Wednesday]," said the source.

"I don't think that the upgrade really added much to the performance we are seeing.

"Maybe a little bit of fuel to the fire - it just helped allow the market to sustain the better performance we've seen across the day.

"It's not the cause of the rally that we've seen. I think the cause of the rally really began yesterday [Tuesday]. We had about three or four days in a row of a very soft tone in the market - always at the close.

"And generally [they were] people selling shorts in the market. Since some people haven't seen any issuance they are starting to buy some of that back," he remarked.

During Wednesday's session, the Brazil C bond added 0.56 to 101.31 bid while the bond due gained 1.40 to 114.55 bid.

"The market kept going up and up," said a trader.

"Brazil caught a nice bid."

Other movers for the day included Ecuador, Russia and Venezuela. The Ecuador bond due 2030 was up half a point to 86½ bid. The Russia bond due 2030 was bid at 1023/4, up ¾ of a point. The Venezuela bond due 2027 added 0.60 to 103.20 bid.

Illiquid issues like Panama and Peru also made gains. Panama's bond due 2008 added one point to 110½ bid while the bond due 2020 jumped up three quarters of a point to 127¼ bid. The Peru bond due 2012 gained 0.15 to 114.15 bid.

Furthermore, the soft dollar is giving support to emerging markets, according to a debt strategist.

"The weaker U.S trade number clearly had an effect on the European currencies.

"There has been a bit of a correlation between, among other things, euro spot and EM spread lately, so I think dollar weakness might be one reason for the performance," said the strategist.

"That's a technical argument, not a fundamental argument."

Philippines up

Philippine's paper surged Wednesday, according to the trader.

"There was a frenzy in Philippine paper. More of it traded today [Wednesday], probably, than has traded in the past year, or maybe more.

"In addition Citigroup issued a pretty bullish research report Tuesday about the prospects for the Philippines," noted the trader.

Citigroup increased its weighting on the Philippines to neutral, citing improvements in the government's ability to carry through with fiscal reforms.

"They said they would be surprised if Moody's downgraded them more than one notch. Citigroup is the third prominent research firm to go on the record now saying that the Moody's action will involve no downgrade or else a low downgrade," he said.

"The market has been expecting two notches at least, and that is what the market has priced in.

Citigroup said that the approval of the VAT increase to 12% in the Lower House Ways and Means Committee is a sign of fiscal progress. The 2% increase in VAT or a rate increase for Napocor could stave off a ratings downgrade by Standard & Poor's and Fitch.

"Usually it would be a head fake when they all go the same way, because it means that their trading desks are long," remarked the trader.

"But anyone who trades the Philippines can tell by the price action over the last few weeks that the Street is short.

"So the fact that these desks are willing to go out on a limb, and make this risky call - when everyone has been thinking that they're going to get a two-notch downgrade and the Street is short - suggests that Moody's may have tipped its hand or that these guys know something that no one else does.

"It just makes no sense for them to stick their necks out, especially when their desks are all short the paper, because it just runs it up and their desks lose money. So it's probably legitimate," argued the trader.

In Wednesday's trading, the Philippines bond due 2015 was bid at 1011/2, up 3/8 on the bid side and 101 7/8 offered, up half a point. The bond due 2025 was bid at 1083/4, 109¼ offered, up 3/4. The bond due 2014 was bid at 99 3/8, up 3/8.

"The institutional volume in Philippines bonds was just insane. Usually 10-30 will trade in a day," the trader said, adding that he saw "north of $60 million in trades" on Wednesday.

"It was all real-money guys buying. And the reason is that they don't want to be short because these things easily have a point to two points to run.

"Keep in mind that there is a rumor that the Philippines is going to tap the [bonds due 2015 and 2025]. So prices screamed, even with that rumor out there.

"Had the rumor not been out there it's hard to imagine what would have happened," he commented.

"Typically what happens is that hedge funds will short these things, and start spreading rumors that there is going to be supply. But it does make sense that we could see a tap on the 2015s or the 2025s. They reopened them in October, and its stands to reason that they would do those again," he remarked.

In the report, Citigroup also said that any spread widening due to new sovereign paper should be a time for investors to build positions.

New paper soon?

Wednesday's positive session may set the tone needed to usher in new issuance. Meanwhile the waiting game for new supply continues, according to the market source.

"A day like today [Wednesday] is certainly a good catalyst" for new paper. There's nothing definitive on the schedule right now," said the source,

"But Brazil has been widely rumored to potentially do something at some point and they are probably less likely to do it in a down market than an up market.

"We finally have an up market, so it could materialize."

Another rumor surfaced Wednesday regarding Turkey. This one said that the government of Turkey rejected a proposed issue of 10- to 15-years in order to focus on the middle of the yield curve, said a buyside source.

Brazil, the Philippines and Turkey are all expected to issue soon, with Turkey rumored to be coming to market this week.

"You talk to brokers dealers on the sellside - there's almost like a pool," said the debt strategist.

"Who's coming first? Is it going to be Brazil? Is it going to be Philippines? Turkey?

"Which one of the three pulls the trigger first?

"Everyone is expecting billion-type deals from all three names," he commented.

Analyzing Moody's move on Brazil

Brazil's corporate sector has been taking advantage of the cash flows into the country, a factor behind Moody's decision to shift the debt rating outlook to positive from stable, according to the debt strategist.

"Moody's rates Brazil B1. S&P and Fitch have already taken them up to BB-. When you look at how Moody's does ratings, they place quite a lot of emphasis on external measures of solvency and liquidity," said the strategist.

The reason behind this emphasis is that what really counts when looking at long-term foreign bonds is the hard currency generation ability of the country, he explained.

"So it is not a coincidence that this improved view follows upon fairly dramatic improvement in external solvency characteristics for Brazil."

In particular, Brazil has made strides in the performance of its trading accounts, he noted.

"They had that record surplus last year. They had a current account surplus last year. That means that there are more dollars flowing into Brazil from the trade performance than flowing out.

"And that has permitted a gradual increase in reserves, which Moody's likes.

"But what is more important, Brazilian companies have been using those additional dollar receipts to pay down their private sector foreign debt.

"And there has been a dramatic decline in foreign debt on the part of Brazilian companies, and I think that is one of the things that Moody's finds impressive," he remarked.

Brazilian corporates were "better today [Wednesday] by 25-50 bps," said a Brazilian corporate analyst. He added that there were no notable big movers that stood out.

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