Emerging markets reel from renewed credit worries; high beta names lead downturn

By Reshmi Basu and Aaron Hochman-Zimmerman

New York, Aug. 9 - Emerging market debt crumbled Thursday amid very low liquidity conditions as risk aversion intensified following more upheaval in the credit mortgage market.

Meanwhile the primary market remained motionless as the broader market suffered severe setbacks to its attempts to pull itself together.

"It's awful," said an emerging markets syndicate desk official.

Emerging market debt came under intense pressure as credit woes reared their ugly head again after the Wall Street Journal reported that that two Goldman Sachs computer-driven hedge funds had liquidated some positions.

Worrying investors further, France's largest bank BNP Paribas announced Thursday that it had frozen three funds that had exposure to the U.S. subprime mortgage sector.

"The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating," BNP Paribas said in a press statement.

In reaction to the liquidity crunch, the European Central Bank injected €94.8 billion into Europe's money markets. By mid-afternoon, there were reports that the Bank of Canada had pumped in C$1.64 billion into the market, a higher than normal amount.

Thursday's market-unfriendly news heightened fears that the subprime mortgage meltdown had spread overseas, fanning a sell-off across global markets as the Dow Jones Industrial Average index plunged 387 points.

And that was more than enough to make for an unpleasant trading day for emerging markets, according to market sources.

"We've been saying for couple days the there were many positives in the market setting up for a significant snap higher, which we saw yesterday [Thursday]," observed a Latin American corporate trader.

"However, the one caveat we pointed to was headline risk - that of banks, brokers or funds blowing up or having major problems.

"That, we saw today [Thursday] and the market subsequently gave back yesterday's [Wednesday] gains," he noted.

Thursday's sell-off follows on the heels of Wednesday's euphoric session, which, for a day, saw a return to conditions before the subprime worries exploded in the middle of July. In trading Wednesday spreads narrowed 18 bps. However on Thursday, the JP Morgan EMBI+ Index widened by 10 basis points, led by a sell-off in high beta credit Argentina, which saw its spreads kick out by 20 bps. Debt from Ecuador and Venezuela also felt the crunch.

In trading, the Brazilian bellwether bond due 2040 gave up one point at 130.44 bid.

Risk re-pricing, says analyst

Thursday's downward pressure can be attributed to another bout of "re-pricing of risk," said an analyst, who added that the day's negative headlines coupled with low liquidity created volatile trading conditions.

However, relatively speaking, emerging markets took the tumbling U.S. market in stride, remarked Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal,

He described Thursday's external debt performance as soft, but there was "not an overwhelming surge of selling" as high beta credits take their cue from the gyrations in the U.S. equity market.

A sellside source seconded that observation, adding that "on the cash side, nothing happened" while the credit derivative swap market was all down.

Recently CDS markets have seen more trading than their cash counterparts since presumably it is an easier way to get protection as investors attempt to hedge themselves to their cash positions. Furthermore it could also be another way to play the market.

But even though EM held its own, the sellside source did not downplay the gravity of the credit story and the potential it has to unravel financial markets worldwide on a day-to-day basis.

"This type of headlines can kill the market very, very fast.

"It was a bad day today [Thursday] just because there is no liquidity at all out there," the sellside source remarked.

Sources cautioned that the concern does not lie within emerging markets, but with the broader credit story and its potentially far-reaching contagion effect.

Local Latin markets pinched

Symptoms of skittishness were felt throughout the domestic Latin American markets, according to IDEAglobal's Alvarez.

Across the region, markets were hit by the U.S. credit crisis. The Argentinean Merval stock index fell 3.27%. And the yield on Mexico's 10-year peso-denominated bond widened 6 basis points to 7.80%.

On the corporate external side, the trader saw good volume across the board in many corporates, including names from Argentina such as Buenos Aires-based electric company Transener and natural gas transporter TGS.

There was also better liquidity for Brazilian names such as airline carriers TAM Linhas Aereas and GOL Linhas Aereas, for state-owned utility Companhia de Saneamento Basico do Estado de Sao Paulo and for beef exporters Grupo Friboi and Bertin Ltda.

Out of Mexico, telecommunication companies Maxcom Telecomunicaciones, SA de CV and AXTEL, SA de CV, glass maker Vitro SA de CV, food retailer Grupo Gigante SA de CV and brewer Compania Cervecerias Unidas SA also posted better volumes.

Nonetheless, all of them were weaker on the day, anywhere from ½ to 1½ pts, observed the trader.

Worries of more to come

One key event during Thursday's session was the European Central Bank's injection of cash, which "the market should've interpreted it as a good thing," a syndicate official said.

But he said that rather than seeing the central bank's move as a step in the right direction, investors saw the move as evidence of a larger problem, "people came back and said, 'Holy ****, things are worse than we thought!'"

A buysider said that many believe there are "other European names in the same situation."

As recently as the end of July, Germany's IKB Deutsche Industriebank created negative headlines because of its exposure to the U.S. subprime market.

Both the buysider and the syndicate official agreed that little has changed in emerging markets, but because of the volatility "it's hard to find a direction," the buysider said.

"The VIX is through the roof," the syndicate official said about the volatility index which hit a six month high of 26.90.

In those circumstances, "the market didn't do so bad," the syndicate official said, specifically about emerging markets.

The new $1.25 billion deal from Russia's OAO Gazprom, which priced Wednesday, is only trading at 5/8 below par, the syndicate official said.

Europe should stay cautious

An emerging markets analyst specializing in Europe urged investors to be cautious with their money while the market undergoes its correction.

"Any spike in risk aversion is a bad thing for markets," the analyst said, adding that correlations between markets have spread misfortune even to sectors where fundamentals remain strong.

The confusion emerging markets now face may be a natural way of dampening overly aggressive buying.

"What the jitters tell us is that investors should become more selective to spread out their risk," the analyst said.

"It's not the thing anymore to buy everything, which has been the case over the last couple of years," the analyst added, commenting: "Which is not a bad thing."

Many countries, despite unfavorable conditions, have been working internally to improve their market standing.

"In Poland, things are improving," the analyst said, adding: "Brazil looks pretty good and pretty solid with good trading position."

Hungary is a country which the analyst feels "requires attention," and Russian "risk is reasonably muted."

Baltic countries, as well as Romania and Bulgaria are having a difficult time as they face the market corrections.

In "Turkey the political outlook is probably not very bright," the analyst said.

It is likely the Army will continue to maneuver "to place their own man" in power, the analyst added.

Nonetheless, AFP reported Thursday that a "moderate figure" was easily elected parliamentary speaker.

"[The] nomination was largely seen as an AKP bid at compromise with secularist forces after a row over its nomination of a former Islamist for the next president [which] in April triggered a crisis and led to snap legislative elections on July 22," the AFP reported.

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