Emerging market paper trades flat to higher; emerging market inflows at $2.2 million

By Reshmi Basu and Paul A. Harris

New York, July 22 - Emerging market debt edged slightly higher Thursday after two straight days of bleeding sparked by Greenspan and a plunge in Treasuries.

The better tone to secondary trading Thursday was a surprise given how equities closed Wednesday and subsequently how they traded overnight, said a market source.

"I would have expected the marketplace to be a little bit softer than it is," said a market source in the late morning.

"It is reasonably constructive right now if you look at where Brazil and Russia and Mexico are trading versus their close last night. They are all reasonably flat to up."

One reason why trading was slightly better is that technicals remain firmer than investors imagined, according to the market source.

"I think there is more cash out there than what was originally anticipated."

There was a lot of two-way flow during Thursday's session in the more liquid issues like the Brazil bond due 2040 and the Russia bond due 2030, according to a buy-side source.

"It seems like Russia is lagging a little bit.

"The market is concerned how the Yukos situation will be solved, so spreads have widened a bit there," added the buy-side source.

Beleaguered Russian oil giant Yukos Oil Co. warned Thursday that it will run out of cash soon because of the government's freeze on its assets and bank accounts.

Russian authorities said they intend to sell Yukanskneftegaz, a subsidiary that produces 62% of the firm's oil and holds 58% of its reserves.

Proceeds would be used to pay $3.4 billion in underpaid taxes that the Government alleges is owed by Yukos from 2002.

The bankruptcy warning pushed U.S. oil prices up above $41 a barrel.

The Russia bond due 2030 was down 0.125 to 91¾ bid.

Also in secondary trading, Brazil was up during Thursday's session. Its bond due 2040 was up a point to 97½ bid while the C bond was up half a point to 94 bid.

And the Mexico bond due 2026 was down a quarter of a point to 1421/2.

Overall, emerging market paper edged slightly higher. The JP Morgan EMBI Index was up 0.15%. Its spreads to Treasuries widened one basis point to 471 basis points.

Emerging markets finally see inflows

For the week ending July 21, emerging market bond funds finally had an inflow, seeing $2.2 million of cash come in, breaking an 11-week streak of outflows, according to EmergingPortfolio.com Fund Research.

Year-to-date inflows amount to $276.3 million or 1.7% of total assets.

Global bond funds had inflows of $130.8 million, for the fifth straight week of inflows. Year-to-date inflows are $2.58 billion, or 3.5% of total assets.

Globe Telecom prices, LG Caltex delays

In primary action, the Philippines' second-largest cellular company Globe Telecom Inc. priced $100 million add-on to its 9¾% notes due 2012 (Ba2/BB) at 109 via UBS Investments. The total amount is now $300 million. The original deal priced at par on March 27, 2002.

And LG Caltex Oil has delayed its $300 million bonds due 2014 until further notice.

The Korean petroleum refining company has been in the middle of a labor dispute, which shut down its refinery Wednesday.

Pricing was expected Thursday.

Deutsche Bank, Banc of America Securities and Citigroup were running the Rule 144A/Regulation S deal.

Meanwhile, Gazprom's bulging books may protect it from the Yukos fallout, given that investors are willing to pay up just to get their hands on it, according to the buy-side source,

"The book is very strong, so that's all that matters right now.

"Being four-times oversubscribed, technicals are going to drive yields lower no matter what's going on," added the source.

"It might trade poorly after that."

But, he added: "You still have an investment-grade collateralized issue, [so] it should be impacted less than anyone else."

Price guidance for Gazprom's expected $1 billion of 15-year notes (-/BBB-/BBB-) is for a yield of 7½%.

ABN Amro, Merrill Lynch & Co. and Morgan Stanley are running the deal.

Philippines still not a buy

Philippine President Gloria Arroyo said she would seek higher taxes to reduce the deficit. Given the political difficulties, investors may want to hold off on the credit, said a market source.

"It's good to see Arroyo looking at ways to tame the deficit, but I think there are still a lot of problems that she has to resolve.

"First, investors would be a lot more reassured if she chose to cut spending, not raise taxes, in order to cover the deficit," he said.

"Higher taxes risk jeopardizing economic growth, which undermines long-term fiscal dynamics. Also, there's no clear sign from Congress that these tax increases will get approved.

"Arroyo did not exactly win the election by a landslide, so her mandate is not quite as strong as she might like.

"Finally, investors need to see a clear plan for how the government is going to extricate itself from Napocor, the state-owned power company.

"With the market still jittery and Moody's still having Philippines on negative watch, I'd wait for some definite progress on the fiscal side before calling it a buy," he added.

Issuers will come

The pipeline has slowed down during recent sessions but will pick up, according to the market source.

"People are still going to lock into expectations that fed funds will be by the end of the year be plus or minus around 2% after a series of moves," said the market source.

Historically, interest rates have never reached their highest levels so quickly after tightening begins.

"So you have to imagine that rates have not peaked yet - that they are still going to be drifting north throughout the balance of the year, only then coming back down towards the second quarter of 2005.

"What that will mean, unless you are a Libor borrower, unless you swap into everything back into floating-rate, guys will probably pay to be prudent in terms of borrowing sooner than later," he added.

But again, issuers are running against a slow summer session.

Merrill sees HY, EM diverging

In the July 22 edition of EuroHYLights, the Merrill Lynch high yield strategy weekly, high yield strategist M. Christopher Garman, CFA and his colleagues note that the recent divergence in US High Yield and Global Emerging Market bond spreads, which began earlier this year, is an anomaly in terms of the recent history of the asset classes.

And they profess the expectation that this divergence will not intensify.

Tracing EMBI spreads and U.S. high yield spreads back to 1994, Garman and his colleagues at Merrill find a high degree of correlation between the asset classes since 2000.

"In the past, [Global Emerging Market] debt overshot during the Mexican, Asian, and Russian crises (1994, 1997, 1998) and out-performed US high yield thereafter going into the 2000-Nasdaq bubble," the Merrill strategists write.

"Since then though, the link has been very close with few signs of divergence, including those that have appeared recently.

"The fact that these were initially emerging-market events likely led to the high yield divergence and [Global Emerging Market] crisis overshooting.

"The case for preserving the link this time around rests on the notion that, barring an EM crisis, deviations are unlikely to be as pronounced or sustained beyond the short term.

"The most recent divergence has been very modest by 1990s standards. Back then, endogenous emerging-market events led to the underperformance of [Global Emerging Market] debt. This time around, there appear to be few signs of a similar impending emerging market crisis. Yet as always, a sustained shock to global liquidity and/or to risk appetites has the potential to make macro frailties in some emerging countries more manifest. Despite the notion that the drivers for both emerging markets and high yield are presently the same, the asset classes seem to be intimating different things: [Global Emerging Market ] spreads are indicating that that risk aversion ought to be rising, while high yield spreads suggest a more sanguine environment."

Mexican corporates flat to higher

In secondary trading, Mexican corporate bonds traded flat to higher.

Mexican cable company Innova's bond due 2007 was up half a point to 103 bid, 104½ offered from Wednesday¹s 102½ bid.

Railroad operator Grupo TFM's bond due 2012 was unchanged at 106 bid, 110 offered.

And Brazilian corporates traded "flat to slightly down on the day," according to an emerging market analyst.

"It went up significantly the last couple of days."

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