Emerging market debt slides on new supply; Brazil's Copom minutes signal higher rates

By Reshmi Basu and Paul A. Harris

New York, Jan. 27 - Emerging market debt slid Thursday as new supply from the Republic of Peru hit the capital markets. Also adding to investor anxiety were minutes from Brazil's Central Bank, which signaled that higher rates lie ahead.

"We started a little bit better and then we came off a little bit off the new issuance from Peru," said a buyside source.

Peru added $400 million in a reopening of its global bonds due November 2033 (Ba3/BB/BB). The retap priced at 106¾ to yield 8.137% via Morgan Stanley and Deutsche Bank.

"It traded up a little bit," said the buyside source.

"It's a pretty long asset so not a lot of people had interest. It came cheap to the curve a little - that's probably why it's a half point up."

In general, investors are a little cautious about adding such a long duration to their holdings, noted the source.

"This is a '33. It's a little bit long. And in a country like Peru there's not a lot of liquidity. I would say even if you like duration, you would have to be really aware of liquidity in Peru," added the source.

Hungary sells $1.5 billion

New paper also came from the Republic of Hungary. The sovereign priced its upsized $1.5 billion 10-year global bonds (A1/A-) at 99.669 for a spread of 57 basis points over Treasuries. Morgan Stanley and Deutsche Bank were also lead managers for the sale.

The buyside source chose not to play in the issue, given how tight the deal came.

Some have said that Hungary falls out of the emerging market universe, given its high-grade ratings.

"External debt has already migrated into more of E.U. type of folders. It's more in the local debt - same thing with Poland (A2/BBB+/BBB+)," added the buyside source.

"So Poland and Hungary, we would look at it but only in the local markets."

Thursday's deals add to this week's supply glut which also saw the Republic of Philippines price an upsized $1.5 billion 25-year bonds at 98.131 to yield 9.70% on Wednesday via UBS, Deutsche Bank and Citigroup.

While the new supply has worn on technicals, it is wise for issuers to tap the market before interest rates rise in the United States, said a debt strategist.

"The market will always accept supply at a price," the strategist explained. "People have funding to do. On balance, worldwide interest rates are relatively low.

"It seems like a reasonable time for issuers to access markets. And probably rates are lower today than they will be three months or six months from now because the Brazilian Central Bank is not the only bank that said they are biased towards raising rates," he noted.

EM slides in trading

With $3.4 billion of new sovereign paper to absorb in just two days, emerging market paper slid Thursday.

Additionally, minutes released from Brazil's monetary policy meeting (Copom) hinted at rate hikes to help stem future inflation.

Last week, the Central Bank lifted its benchmark Selic interest rate by half a percentage point to 18¼%.

Not helping matters on Thursday, U.S. Treasuries fell as factory orders for durable goods increased 0.6% in December. The yield on the 10-year note closed out the day at 4.22% from 4.19% at Wednesday's close

"Today's [Thursday's] strong U.S. economic data are putting some pressure on EM, but I think the biggest factors at play today are all the new supply coming into the market and the hawkish comments from the Copom in Brazil about future interest rate increases," said an emerging market analyst.

The Brazil C bond lost 0.188 to 102.187 bid while the bond due 2040 fell 0.65 to 115.10 bid. The Mexico bond due 2009 slipped a quarter of a point to 121.35 bid. The Venezuela bond due 2027 dropped 0.40 to 102.85 bid.

"I think overall, it's a good thing that we haven't widened out more," observed the buyside source.

"And it looks like the widening wave has pulled back a little bit, so we are kind of stabilized at around a 360 level - I think that's a good sign."

Looking ahead, market action will depend largely upon the forthcoming slew of U.S. economic data, which could alert investors to the pace of rate hikes or maybe not, according to sources.

"That could put us out of balance. For now, it's a fairly neutral tone," said the source.

The buyside source added that the incoming data would contain mixed messages at to the state of the economy in the United States.

"It's going to be really hard to find directionality based on that. I think as long as there isn't really bad, bad data coming out of the U.S., we are going to hold up pretty well."

Nonetheless, next week's data could play spoiler to spreads and price action.

"But a sustained rise in [U.S.] interest rates would clearly hurt EM and could push us back to EMBI+ spreads at 380bp - if not higher - in a hurry. The big US economic data out next week, ISM and the payrolls data, could really drive this market if they bring any surprises," added the emerging market analyst.

As the debate over the pace of global growth rages on, a strong world economy benefits emerging markets, said the strategist.

"A weaker economy, you might think, 'Oh, that takes pressure off of rate hikes and it is good for technicals.' But fundamentals are more important than technicals. And emerging markets still do better in a strong world economy.

'I still think there is tremendous potential for real data to move pricing, but there is again two opposite trends.

"The high frequency data recently has been a little bit better than most people expected. Consumer sentiment was positive. Durable good orders was a nice number. It looks like the growth scenario is intact. Having said that, oil at $50 is not going to do the world economy any favors," he commented.

Inside the Copom minutes

The market is betting on further rate hikes in Brazil, given the hawkish tone of the Copom minutes. Don't assume too much, according to the debt strategist.

"I think they are going to follow the data, and if measured inflation moves higher, then they will probably fight it, but it's going to be really a question of how the numbers come out," he said.

Two different dynamics are at work, which makes it increasing difficult to forecast inflation, he said.

"On the one hand, the Brazilian economy probably has been stronger than the Federal Bank expected because it's stronger than most people expected.

"Domestic demand is clearly a source of some upside pressure on prices," which leads to the assumption of more hikes ahead.

"On the other hand, the Brazilian economy has been stronger than what everyone expected - a lot of pricing appears to be driven by that - that should be a sort of disinflation in Brazil," he remarked.

And the wild card in this game is the price of oil, currently playing around $50, he said.

"I think the market is probably pricing in a little bit more in terms of Copom rate hikes for early this year, but probably looking for a peak by the middle of the year and still thinking of the possibility of declines before the end of the year.

"I think that's where the outside consensus might be for the moment," he remarked.

"I think it's a Central Bank that is doing its job and responding to its inflation targeting mandate. I think they are earning their pay."

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