Emerging market debt scores gains ahead of jobs data; EM fund outflows at $107 million

By Reshmi Basu and Paul A. Harris

New York, March 31 - For the third straight session, emerging market debt posted gains ahead of Friday's crucial release of U.S. non-farm payroll numbers.

For the last three sessions, U.S Treasuries have rallied, which have helped end a recent slide in emerging market debt. During Thursday's session, the yield on the 10-year note compressed after the release of February's personal income data.

The data showed that core personal consumption expenditure price index was up 0.2% in the month, down from a 0.3% rise in January. That news helped ease inflation concerns.

The yield on the 10-year note stood at 4.48%, improved from Wednesday's close of 4.56%.

The Treasuries bounce helped drive up emerging market price action.

"It was mostly a hedge fund play," said a buyside source.

"Everybody who had shorted bonds in the past few days decided to cover in the morning. After covering, they put some more shorts on. And I think what happened was that there was some real money that got involved and that provided support for the market," said the source.

Emerging markets such as Brazil saw firmer prices. The Brazil bond due 2040 gained 1.05 to 111.15 bid. The Colombia bond due 2008 was up one point to 106 bid. The Ecuador bond due 2030 surged 1¾ to 89¾ bid. The Russia bond due 2030 added 1 1/8 to 102¾ bid. And Venezuela's bond due 2027 packed in one point to 99.30 bid.

Fund outflows at $107 million

Emerging market flows have finally caught up to the bearish tone in the market. Emerging market bond funds had outflows of $107 million in the week ending March 30, according to EmergingPortfolio.com Fund Research.

This is the second straight week of outflows but still leaves inflows year-to-date at $2.5 billion. Last week, emerging markets saw $136 million exit, in the first outflow this year.

Global bond funds had inflows of $189 million in the week, about half of the inflows seen the previous week. These funds have had $5.02 billion of inflows year-to-date.

Waiting on payroll numbers

The buyside source said she was waiting for Friday's payroll number for more clues as to how the Fed will act. That coupled with Thursday marking the end of the quarter has kept investors sidelined.

"What the market needs, both in the U.S. and in our market, is at least two, three or four data points that come in the same direction because it has been all over the place and no one can really decide on a direction," added the buyside source.

"Every time there is good news, the market rallies. Every time there is bad news, the market sells off. But I don't think anybody has a good vision for the medium term.

"I think what we all need is to get a series of data that is consistent with each other.

"I think the market will look at it [job numbers] as a starting point," said the source.

Market consensus is that the number will be 221,000 jobs added, down from a gain of 262,000 in February.

A second buyside source agrees that the payroll numbers are "big" as they always are.

"If the numbers come in strong, that means the Fed continues to be aggressive, which will keep pressure on spreads," he said.

"If the number comes in softer, then the Fed will not be as aggressive and that would be good for spread product," he said.

The first buyside source, who holds a neutral position, has held off on making any adjustments, given the lack of market direction.

"I have to say we're waiting for tomorrow's [Friday] numbers to see if that gives us any direction," said the source.

The source is in a position to add on weakness.

"We are looking for a little bit of consolidation here and try to figure if there is another leg to go on this sell-off or if it's time to say: 'okay this is cheap enough and we're going in.'"

Cheaper valuations

Valuations are now cheaper than they were two weeks ago, which many have said is a good thing for the market.

"I think that we were due for a correction and that's probably a welcome one," added the buyside source.

The source added that the correction was needed because spreads could not go any tighter from the 300 basis points level.

"I wouldn't go as far as saying that everything is cheap on a historical basis," the source said.

"I think it's all relative and you have to look at it versus the U.S. still."

The source added that the market is getting closer to a point where emerging markets debt is becoming interesting again.

"That doesn't mean that there isn't room for it to cheapen more from here. That wouldn't be surprising, but it isn't necessarily what we are looking for here.

"This might prove to be a good entry point."

The second buyside source agreed that the recent correction has made it easier to get excited about the market.

"Before we were buying stuff at six and seven handles, now you can buy quality stuff with eight handles. It's a little bit easier."

Meanwhile, the correction has also dampened the primary market. Activity there can only be revived if stability returns.

"You clearly had a slowdown," said the second buyside source. "The high-yield market seems to have grinded to a complete stop."

He added that emerging markets could see a rally even without stability returning to high yield.

"The flows [in EM] have been much better. Nonetheless, the two have some linkages."

Political stories to watch: Colombia, Poland

The first buyside source said she was paying close attention to how the Constitutional Court in Colombia rules on the re-election attempt by Alvaro Uribe, who took office after winning the presidential election in August 2002.

In November 2004, the Colombian House of Representatives voted 113 to 16 to pass legislation that would allow him to run for re-election. The Constitutional Court must now decide if the measure can be allowed.

"We are trying to get a feel on how the Constitutional Court is going to rule on the re-election bill of president Uribe," said the buyside source.

"I don't think there is any other major worries in Latin America right now but [Venezuela's president Hugo] Chavez - which is always there."

The source added that elections in Poland are something that should be monitored over the next few months, particularly the potential for early elections.

"There's things happening all the time, but I think those are key issues where the outcome will be very important for bonds."

The second buyside source added that Colombia has underperformed, but is not worried about Uribe's election attempts unlike the market.

"It's not that it has done anything wrong. It's just that other countries like Panama and Peru have done more to improve," he said.

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