Emerging market debt rises as Treasuries dip below 4%; El Salvador prices $375 million 30-year paper

By Reshmi Basu

New York, June 1 - Emerging market debt held up in trading Wednesday, supported by U.S. Treasuries which pushed even further below 4% on soft economic data and worries over the future of the European Union.

"We saw emerging market spreads widen today [Wednesday], but I think the focus today [Wednesday] was on the Dutch vote on the E.U. constitution," said a buyside source.

"Turned out to be a 'no.' But I think the market in general has held up well," replied the source, adding that the market expected an emphatic rejection by the Dutch.

The real reaction is yet to be felt, said the buyside source.

"We'll have to see tomorrow when it [the market] opens in London because London was closed today [Wednesday by the time the vote results were released], so Turkey and all the other European papers that would react more were already closed by the time the results were out.

"I don't expect a very huge reaction. I think it was priced in," remarked the source.

Flight to Treasuries

The story behind the performance of the euro has given support to emerging markets, according to a Latin America debt strategist at Refco EM.

The euro has fallen to an eight-month low against the dollar, burned by France's rejection of the E.U. constitution on Sunday. The "no" vote has prompted investors to sell euros on increased worries of slower economic growth and integration problems.

That has created uncertainty in world markets, in turn generating a flight to quality to U.S. assets, said the strategist.

"The Treasuries has been recipient of investors," he said.

"And then this morning, we received the number on manufacturing which was lower than expected," he noted.

The Institute for Supply Management said its headline index dropped to 51.4% in May from 53.3% in April.

The number showed a slowing economy and also raised the possibility that the Federal Reserve will skip raising rates at its next meeting, noted the strategist.

This helped push the yield on the 10-year note to 3.89% by the close, as the benchmark continued the run that saw it break through the 4% barrier Tuesday.

"That has given bond investors among those emerging markets a [price] rally today [Wednesday]," he said.

The buyside source added that there were no major flows during Wednesday's session. Mostly hedge funds and trading accounts took part.

The Brazil C bond moved up 0.062 to 101 1/8 bid while the bond due 2040 fell 0.20 to 118½ bid. The Mexico bond due 2009 added 0.20 to 109½ bid. The Russia bond due 2030 rose 1.062 to 110.937 bid. The Turkey bond due 2030 jumped 1 5/8 points to 140 5/8 bid.

Putting cash to work

The buyside source added that investors are coming out of the wait-and-see mode that has dominated emerging markets for many weeks.

"I think a lot of people are expecting a sell-off, but it hasn't come yet. You start wondering: 'Okay did I miss the low here and should I just go with the momentum and invest my cash?'

"I think a lot of people have done that over the past few weeks.

"It's still hard. We have the summer ahead of us and I think there will be some more room for widening," added the source.

Additionally, the buyside source is surprised as to how low yields on Treasuries have gone.

"I want to say it's a good thing. But it's going to depend why they're low. If we're heading into a recession, it might not be such good news for some of the emerging market countries. I think right now that's a supportive technical."

Venezuela up, despite politics

One area of concern for the strategist is the political uncertainty in Venezuela, stemming from president Hugo Chavez's threats to cut diplomatic relations with the United States.

Of interest is the "noise coming out of both countries and how the market has completely ignored that. And Venezuela keeps on moving higher," said the strategist.

"I think Venezuela is rewarding investors that are bullish there," he said.

Higher oil prices have lifted the country's paper. The Venezuela bond due 2027 rose 0.60 to 101.10 bid.

And in Argentina, "the conclusion of the restructuring chapter and the performance of economic assets is slowly moving assets there," he remarked.

Standard & Poor's also raised Argentina credit to B- on Wednesday, a plus for its paper, he added.

The upgrade reflected completion of the debt restructuring.

El Salvador issues $375 million

The Republic of El Salvador priced an upsized offering of $375 million of 30-year bonds (Baa3/BB+/BB+) at 99.474 to yield 7.695%, a spread of Treasuries plus 345 basis points, according to a market source.

The deal, increased from $300 million, came in line with price guidance. Earlier in the session, guidance had been set in the area of 345 basis points more than Treasuries.

Deutsche Bank Securities ran the Rule 144A/Regulation S deal.

And after market close, Mexico's Pemex priced $1 billion of 10-year bonds to yield 5.76% and $500 million of 30-year bonds to yield 6.7%.

"Pemex is a credit that needs to come to the market very often," said the Refco EM strategist.

"Their level of investment requires access to capital markets throughout the year.

"The window of opportunity is what they have to choose well and I think in this case, they have chosen well."

Credit Suisse First Boston and Lehman Brothers ran the deal.

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