Emerging market debt spreads widens; Investors shift into neutral

By Reshmi Basu and Paul A. Harris

New York, May 3 - Emerging market spreads widened Monday as investors eyed the upcoming Federal Reserve meeting and U.S. employment data.

"Investors are still on the sidelines, looking for some sort of signal as to how the Fed will react," said a Chicago-based trader. "Right now, people are trying to see if the numbers will come in line with expectations."

Furthermore, he added, "People won't buy until they know that the market has hit the bottom range. And the market just can't find buyers."

The JP Morgan EMBI Index was down 0.82% in light trading as London and Tokyo markets were closed. Its spread to Treasuries widened by eight basis points.

"In Asia, it has been pretty steady," said another trader. "Spreads are a couple of points wider."

"Philippines, relatively speaking, is holding in pretty well, with everything that is going on in Brazil today. The Brazil '40s are off almost four points," added the trader in the early afternoon.

Rebounding somewhat in late trading, the Brazilian bonds due 2040 were at 90.75 bid, 91.40 offered in afternoon trading, down 1.75. At session's close, the bond was at 91.25 bid, 91.60 offered.

The benchmark C bond was down 0.55 to 91.065 bid, 91.250 offered at session's close.

"Both the Cs and the '40s are hovering around 90, now. I think that with Treasuries kind of hanging in, certainly those bonds have underperformed in spread terms, added the trader.

While Asia fared far better in Monday's trading, Latin American assets sunk further as Brazil, Panama, Ecuador and Venezuela all registered losses on the EMBI Index.

Ecuador plunges

Rumors that Ecuador's austere finance minister Mauricio Pozo will resign have derailed the country's performance in the last week. In trading Monday its EMBI component fell 3.34%. Its spread to Treasuries widened by 28 basis points.

Adding to investor uneasiness, the country said that it would delay by a year a $50 million payment to the International Monetary Fund.

Meanwhile, the Brazilian component of the EMBI index slipped 1.23%. Its spread to Treasuries widened by 15 basis points.

"I think the Asian sector has way outperformed today. Does it catch up tomorrow? And does Brazil hit a bottom, here? Those are the big questions," said the trader.

Meanwhile, market conditions have scared away both investors and issuers. Adding to the buyers' blues is that some investors are still overweight in Brazil,

"Right now I think every deal, regardless of what it is or who is bringing it, is going to get pulled off the road right now.

"People are not motivated to buy. They're defensive," said the trader.

"Part of the reason is that Brazil represents a huge proportion of the EMBI. People are sitting with that much of an overweight, and we're down 6% or 7% for the month."

Go with individual issues, suggests strategist

In response to an inevitable rate hike, investors have shifted into neutral, reducing their exposure in volatile markets. But investors will likely sell more, depending on the direction of this week's economic data.

"Investors are trying to clear their decks in case the employment numbers this week come in a lot stronger than expected," said an emerging market analyst.

"Many EM investors have unwound a lot of their overweight positions in Brazil and Turkey, but the market is still not underweight by any means.

"With a lot of potential Fed risk coming up this week, most investors would rather play it safe and try to get as close to neutral or even underweight as possible," he added.

As money becomes more expensive, look at individual issues and let market trends guide not dictate, said a strategist.

"We've been underweight in the benchmark duration and most of our portfolios have been this year," said the strategist.

"Most investors are looking at basically neutralizing their ratio risk, while looking for individual ideas that will outperform their particular benchmarks," said a strategist.

"We find individual issues that we like more than broad sectors of the market are particularly attractive. We generally recommended looking through emerging markets for individual ideas that compliment the exposure to broader portfolios than EM benchmark allocation," recommends the strategist.

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