Emerging market debt suffers early losses on credit fears, partly rebounds near end of session

By Reshmi Basu and Paul A. Harris

New York, May 11 - Emerging market debt erased some losses late Wednesday after buckling early in the session under external pressures from credit quality worries.

A buyside source said that continuing fallout from the downgrades of General Motors Corp. and Ford Motor Co. was creating jitters earlier in the session. Economic data also pushed bond prices down.

New supply from Brazil and Uruguay had little effect on the debt market, given the relatively small size of each offering, sources said.

"We're certainly weaker, but I don't think it's really related to the new issuance," said the buyside source.

On Tuesday, Brazil reopened its 8 7/8% bonds due October 2019 (B1/BB-/BB-) to add $500 million via Goldman Sachs and Merrill Lynch. The retap priced at 100 3/8 to yield 8.827%.

And Uruguay sold $300 million of 12-year bonds at par to yield 9¼% via Citigroup

"I think it has to do with the current risk aversion that we have seen in high-yield and high-grade, which is certainly affecting emerging markets," added the buyside source.

The source said that there was definitely much more volatility in the market.

For instance he noted that half of the volume that brokers saw on Tuesday was in the new Brazil 2019 bonds, which was down as much as two points at one stage in the session.

"Some of the people were initially excited about buying a low dollar-price bond," he remarked.

Furthermore, people are becoming more defensive, he said.

For instance, he spotted the 2019 bond at 98¼ bid, 99¾ offered.

"It came at 100 3/8 so if you wanted to sell it now you're almost two points in the red," he commented.

However the issue recovered some of the losses and was seen at 99¾ bid late in the session.

Meanwhile, he said that emerging markets continues to outperform high yield.

"It still seems to be the case that the emerging markets have held in much better than high yield," he said.

"But what we have heard is that some of the high yield accounts that are suffering redemptions are finding better liquidity in their EM positions.

"So if they need to raise money they are going to sell their EM because there is really not a bid right now for most of the securities in the high yield," he remarked.

Volatile day in Treasuries

U.S. Treasuries played a role in Wednesday's down and up session for emerging markets. A surprising trade deficit number in the United States, hedge fund concerns and a runaway plane added volatility.

Early in the session, Treasury prices fell on unexpected news that the U.S. trade deficit narrowed 9.2% in March to $55 billion, indicating the economy is strong and raising concerns about the pace of future interest rate increases.

Treasury prices were also helped in the morning by speculation that certain hedge funds were in trouble as a result of their exposure to General Motors Corp., prompting a flight to quality.

Evacuations at the White House and U.S. Capitol building due to a wayward plane sparked a short-lived spike in prices in the afternoon. But the market calmed down when it was learned that the incident was not a security threat.

Nonetheless, Treasuries ended mostly flat as the yield on the 10-year note stood at 4.20% late in the day, compared with 4.21% Tuesday. During the session, the yield on the 10-year hit a high of 4.23% and an intraday low of 4.17%.

Additionally, varying sentiment from the U.S. market is pushing Latin America debt to "whipsaw", according to Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal.

Tuesday's negative tone in both the collateralized debt obligation (CDO) and credit default swaps (CDS) market in the United States influenced Latin America earlier in the session, said Alvarez. In the early going, that appeared to be the motivation behind more buying in the Treasury market.

"So Latin America slowly but surely began eroding. But then you had higher inflation number in Brazil on the retail side - that also influenced prices there," he added.

The news out of Washington raised the security issue again, said Alvarez, which added to more securities buying.

"But then later in the afternoon as things started to get quieter, we had a bounce back," he said.

"I think we have a bounce back due to the fact that Treasuries tend to be quite strong in the U.S. with 4.21% yields.

"Players in Latin America that may have shorted the market expecting more fireworks to come out of the U.S. on the CDO and CDS front today [Wednesday] were disappointed. And we're starting to cover," he remarked.

Another market source added that the emerging debt firmed on the late rally in the equities market.

During Wednesday's session, the Brazil C-bond added 0.062 to 100 5/8 bid while the bond due 2040 moved up a quarter of a point to 114.40 bid. The Ecuador bond due 2030 gained a quarter of a point to 81 bid.

Out of Latin America, The Russia bond due 2030 rose 0.37 to 107.12 bid.

Hedge fund rumors may come back

On Tuesday, the Dow Jones Industrial Average fell 1% on speculation about problems at hedge funds. There were rumors circulating that certain hedge funds were in trouble as a result.

"The hedge funds were long in the more speculative part of the credit spectrum, and short on the high quality sector," explained the buyside source.

"So this risk aversion trade has caused them to lose money on both the long in the low-quality and the short in the high-quality, because both have basically moved in opposite directions.

"There was talk of some of the hedge funds trying to liquidate other securities to cover the losses in this particular trade," he added.

Earlier in Wednesday's session, the lingering rumors added softness to the market, remarked Alvarez.

"It's quieted down now because you haven't had confirmation or new names added to the bunch that were gossiped about yesterday [Tuesday]," he said.

"Nonetheless, I would expect this will be a building situation."

While the rumors have since died down, Alvarez warned that this is not a one-time event, "where it was rumored yesterday and it goes away."

"I think that for a market that is as complex as CDOs and CDSs, there's probably more than meets the eye. And it will probably take a few weeks to play out. It's sort of a dying story on an intra-day basis, but something that should come back again."

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