Emerging market debt down; market liquidity blamed for sell-off

By Reshmi Basu and Paul A. Harris

New York, April 29 - Emerging market debt took another hit as some investors faulted the market's liquidity for this week's downward spiral.

"Over the past three trading sessions there was a lot of sell off," said a trader.

"A large EM hedge fund in Europe had $400 million of the stuff across the board and hit every single broker you can imagine and put substantial pressure on the price.

Among the fund's holdings was debt from Russia, Latin America and Eastern Europe.

"And they needed to liquidate," explained the trader.

"It was technically driven lower, just as we saw in the first part of the year emerging markets was technically driven higher.

"This is all a liquidity problem. It has nothing to do with the fundamentals," said the trader.

At the close of Thursday's session, the JP Morgan EMBI Index was down 0.68%. Its spread to Treasuries was wider by one basis point.

Brazilian corporates slip with sovereigns

When the Brazilian sovereigns hurt, so do the corporates, said a research analyst.

"In terms of bond prices, it's very tight. The high quality corporates in Brazil, which most of them are, are very tight to the sovereign," said the analyst.

"I think the fundamentals are strong for the majority of them, but you have the ups and downs in the sovereigns."

In terms of new issuance, he said the market had no appetite.

"People are a little cautious that the market might be too optimistic," he added.

In trading Thursday Brazil's bond due 2040 was down 0.10 to 91.9 bid, 92.35 offered.

The Brazilian benchmark C bond was up 0.25 to 91.125 bid, 91.25 offered.

The trader said he saw a low of 90.5 on Wednesday for the C bond. At one point, it was bid at 92.25 Thursday.

"They had a substantial rebound but most of it was short covering," said the trader.

"Ecuador is down a buck and a half, but I'm sure the locals are the ones who are selling," the trader added.

In late afternoon, Argentina, the Philippines and Russia were flat.

"Turkey is off 0.75," said the trader.

GDP data signals early rate hike

Meanwhile worries about rising interest rates continue to keep buyers on the sidelines as the latest batch of economic data reinforced the uneasiness.

"I don't think you have a lot of buyers out there. I don't think they're in any condition to buy in this market right now," said the trader.

"I get the impression that cash levels are high - near 10% - after selling a lot of assets over the past couple of weeks.

"But this is inevitable. Suddenly everybody has a different picture of interest rates. And the first one that gets whacked is EM.

"And of course they're the first ones to benefit when you have a lower interest rate environment, because that allows them to refinance their very, very expensive external debt at much lower levels," added the trader.

New economic data on Thursday was another nail in the coffin for hopes that the Federal Reserve might not move quickly. The U.S. economy grew by a sound 4.2% in the quarter although that was below economists' forecasts of 5%. However, the core personal consumption expenditures index rose to 2% from 1.2%, signaling that inflationary pressures are lurking.

"The process is now reversing. This should not be a shock to anybody, especially considering the recent economic data, including today's, which still signals a strong U.S. economy, and hence higher rates, sooner rather than later," added the trader.

Spreads may have to widen more for emerging markets to find a new range, said an analyst

In early April, emerging markets debt was range-bound. But now bonds appear to have fallen through that range. But the unknowns may still keep buyers at bay until it is clear what that new range will be.

"We'll see bargain hunters at some point, but investors are going to want to be sure that these are really bargains before they dip back into the market," explained the analyst.

China slowdown may hurt

Some investors have said that another threat has surfaced for emerging markets. Chinese Premier Wen Jiabao said that his country's government is committed to cooling its economy.

Chinese demand has pushed up prices for many commodities that have been a boon to Latin America's economy. If China is successful in curtailing its growth, some fear that commodity prices may fall again.

"Nobody really knows what higher U.S. rates and/or a China hard landing could do to this market, so credit spreads may have even further to go before the market finds a new range," added the analyst.

"With the debacle of the past several days everybody is trying to see what is the real range," commented the trader.

Hutchison Whampoa wider

Also in trading Thursday, Hutchison Whampoa saw its spreads widen in Asia - but then it slightly rebounded as the London markets opened.

The Hong Kong telecommunications company's 6¼% bond due 2014 closed at 200 basis points bid, 195 bps offered. That was 1 bps wider than Wednesday's close of 199 bps bid, 194 offered. Its 7.45% bond due 2033 closed at 253 bps bid, 248 bps offered, five bps wider than Wednesday's close of 248 bps bid, 243 bps offered. And its 5.45% bond due 2014 was bid at 210 bps, 205 bps offered, five bps wider than Wednesday's 205 bid, 200 bps offered.

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