EM 'election rally' fades into New York morning; Russia, Korea CDS widen from Tuesday tights

By Paul A. Harris

St. Louis, Nov. 5 - Rallying emerging markets prices that may have been partially in response to the U.S. elections that produced a new president-elect, Democrat Barack Obama, faded as the Wednesday session unfolded in Europe and North America.

Most Latin American credits were down 1% to 2% by the middle of the New York afternoon, according to Enrique Alvarez, head of Latin American debt strategy for the financial research firm IDEAglobal.

At the same time, the EMBI-plus was off 2.06%, trading at a 599 basis points spread to Treasuries, 35 bps wider on the day.

It had traded as tight as 583 bps on Tuesday, the strategist added, noting that by way of contrast, on Oct. 24 the EMBI spread hit a wide of 862 bps.

Meanwhile the primary market remained dormant, as it is apt to remain for the near to intermediate term, sources said.

Driven by technicals

The general sentiment in emerging markets improved a lot during the first two sessions of the week, according to a London-based trader who focuses on Kazakh, Ukrainian and Russian risk and who spoke early in the New York morning.

"We have seen tightening for the past seven or eight trading sessions," the trader said.

"Tuesday was a very good day. Today is a good day also, but we are off the tights in external debt because some people follow the rule, 'buy the rumor, sell the fact.'"

The market was dramatically oversold, the trader added, striking a theme that others would light upon in conversations with Prospect News throughout the Wednesday session.

"We reached truly distressed levels in bonds, and extremely wide levels in CDS that were not justified by fundamentals," the source added.

"But some people have taken heart in the U.S. elections, saying that an Obama administration is going to be good for U.S.-Russia relations."

Russia CDS narrow 900 bps in 10 days

Russia's five-year CDS was "a little wider" on Wednesday at 450 bps, said the trader, who added that Tuesday's spot was 400 bps, and conceding that in 2007's market a one-day 50 bps move would have been huge.

Nevertheless, 10 days ago Russian CDS widened to 1,300 bps.

Noting that the all-time tights in the Russian synthetic was 35 bps in June 2007, the trader recounted that two months ago it was still trading around 120 bps, and widened very gradually to levels of 300 bps to 350 bps in September.

"That's when things started going crazy, and we widened to 1,300 bps," the trader added.

"We tripled the spread of a country that has a fiscal surplus, a current account surplus, and had more than $500 billion of reserves.

"But people were so worried that they got out of rubles, Russian external debt, Russian equities...out of everything."

The drastically oversold situation came about for several reasons, the trader added.

The Lehman Brothers bankruptcy gave rise to selling of cash bonds because of the Lehman repo program.

"Also some clueless hedge funds didn't recognize that the picture had changed, both in fundamentals and technicals, and ran into difficulties very quickly," the trader added.

In addition some of the real-money investors needed to decrease their exposure to the market, which also brought them into the sell-off.

"That's why the sell-off was very severe," the source said.

Higher-beta CIS in synch

The higher-beta names in the former Soviet states saw moves that were approximately proportional to the Russian moves the trader said.

On Wednesday Ukraine five-year CDS was at 1,550 bps bid, 1,700 bps offered, wider than Tuesday's 1,500 bps bid.

Eight days ago Ukraine CDS was at 3,200 bps bid, the trader said, noting that this gargantuan widening began in late September into early October from levels that started in the context of 650 bps and 700 bps.

The all-time tights in the Ukraine synthetics was 126 bps in June 2007, "very tight to Russia," the trader said.

The prime culprit in all of this volatility: once again the hedge funds, the trader said.

"They didn't know this credit, but thought they knew alpha, and all piled into the same trade," the source contended.

"They all were getting out because of funding problems. Hence every bid was a good bid. And the market was not orderly.

"It had nothing to do with fundamentals. People just needed cash to meet redemptions."

However, the trader added, over the past seven or eight trading sessions the buyers that were always there, who were waiting until this move played itself out, started buying.

Back to the economy

The last leg of the recent EM rally played out during the New York morning, according to IDEAglobal's Alvarez.

That's when investors once again began turning attention away from the U.S. elections and back to the economy.

The ADP National Employment report, by Automatic Data Processing, Inc., noted that United States employers cut an estimated 157,000 jobs in October, the biggest decline in almost six years.

Elsewhere, the Institute for Supply Management reported that its non-manufacturing index fell drastically in October to 44.4% from 50.2% in September.

"That forced the market psychology back into the weakness of the U.S. economy and the global recession, which had not been driving prices for a number of days," said Alvarez, adding that hence emerging markets were driven to lower levels.

Brazil's 11% bonds due in 2040, one of the benchmarks of the emerging markets asset class, was at 118.10 bid, 118.50 offered on Wednesday, Alvarez said.

Volatility in emerging markets has rocked this asset, too, Alvarez noted, specifying that from a dollar price of 132 on Sept. 8 it fell to 99 3/8 bid, on Oct. 22.

Hence, said the strategist, the Brazil 2040 suffered a 30% drop, and has now recovered 18% of it.

Asia also called oversold

Asian credits pulled back substantially from the "squeeze tighter" they had seen during the previous 48 hours, said a trader in New York, just after the close there.

Korea five-year CDS widened to 325 bps on Wednesday, after trading all the way down to 250 bps on Tuesday.

Meanwhile higher-beta Asia also tightened "an enormous amount," the trader said.

"Indonesia CDS have almost come down by a factor of three from where they were at the wides.

"Philippines CDS traded as wide as 860 bps. At one stage, Tuesday, it got inside 300.

"We just faded a little from those levels on Wednesday.

"But that's almost 600 bps of tightening in three or four sessions."

As with the trader in CIS names, the Asian trader said that the market had been egregiously oversold.

"There was complete capitulation, and panic-buying in the early part of last week," the source said.

"In that kind of situation people get trapped in bad positions which quickly go 50 or 100 bps in the wrong direction.

"They become forced to cover."

No primary in sight

Sources do not look for the recent rallying in EM, technical or otherwise, to provide a window of opportunity for issuers to address looming maturities.

"It would still be hard to get deals done," a trader said.

"That was one of the reasons we widened so much - because of concerns about refinancing risk."

Instead governments and central bankers have had to step in and address those near-term refinancing needs.

"That was one of the reasons why things turned around so much," said the trader.

"The fact that the Fed was providing facilities to the Korean and Singapore central banks really took some of that near-term risk out."

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