Emerging market debt rallies on subdued CPI data; Korea prices $1 billion; $53.1 million fund inflows

By Reshmi Basu and Paul A. Harris

New York, Sept, 16 - Emerging market debt surged Friday on soft U.S consumer price index numbers as the Brazil 2040 bonds in particular scored high.

U.S. consumer prices rose a mere 0.1% in August, while core CPI also came in at 0.1%, below market expectations.

Those numbers provided reassurances to investors that the Federal Reserve will stick to its "measured pace" rate hike strategy and helped push emerging market debt higher as U.S. Treasuries had their biggest gain in six weeks.

"Brazil is up significantly today [Thursday]. But the main reason behind the strong rally is the function of the very benign CPI numbers that came out in the United States," said Alberto Bernal, head of Latin America research for think tank IDEAglobal

Overall, emerging market paper soared during heavy trading. The JP Morgan EMBI+ jumped 0.56%. Its spread to Treasuries tightened one basis point to 421 basis points.

"There was a lot of buying, particularly in Brazil," said a buy-side source.

"It was pretty much split between buying from accounts and a little bit of a Street-driven rally there," added the source.

"It was mixed, but overall a lot of flows in Brazil '40s."

And Brazil was up. The C bond rose 0.687 to 99.062 bid while the bond due 2040 added 2.15 points to 111.45 bid.

Emerging market funds at $53.1 million inflows

Emerging market bond funds took in $53.1 million of cash in the week ending Sept. 15, according to EmergingPortfolio.com Fund Research. This is the sixth straight week of inflows, during which time these funds have pulled in a total of $324.6 million.

Inflows are $516.9 million for year-to-date, which is 3.2% of their beginning of year total assets.

Global bond funds had inflows of $143.8 million in the week, the seventh consecutive week of inflows and the 12th week of inflows in the last 13 weeks. These funds have $3.6 billion of inflows year to date.

Korea oversubscribed

In the primary market, the Republic of Korea saw strong demand as it priced $1 billion of global bonds at 99.29 to yield Treasuries plus 85 basis points.

One source said the book size was around $3 billion and added that most of the orders were from Asia.

Barclays Capital, Citigroup, Deutsche Bank and JP Morgan were lead managers for the Securities and Exchange Commission-registered global bond offering.

Also from Asia, Hong Kong's Panva Gas Holdings Ltd. priced an upsized $200 million of bonds (Ba1/BB+) at par to yield 8¼% via Merrill Lynch and Morgan Stanley.

And Russian Standard Bank priced an upsized $300 million of three-year notes (Ba3/B) at par to yield 7.80%.

ING and Dresdner Kleinwort Wasserstein ran the books for the Regulation S deal.

Russia's Paris Club exchange

Russia is considering exchanging Paris Club debt for eurobonds, much to investors' chagrin.

"There's not a lot of clarity on what exactly is the form in which they are going to do it," said the buy-side source.

"But what they are actually trying to do is reduce some of their Paris Club debt."

Russia can do this in two ways. They can purchase their debt by using cash or use the proceeds from a bond sale to cover Paris Club debt, according to the source.

"It's not clear yet what option they will go for," said the source. "Obviously, the first option would be very positive because they wouldn't be coming to the market for that.

"They would just be using their cash and reducing their debt, so that's fine.

"But actually issuing bonds to buy back that debt doesn't really help us because it adds supply to the market. And their debt ratios are not better in any way," added the source.

The Russia bond due 2030 fell 0.251 to 96.062 bid in trading Thursday.

Impact of Brazil's rate hike

On Wednesday, Brazil's central bank's raised the Selic rate by 25 basis points to 16¼% in a 5-3 vote. Furthermore, the bank said it plans to hike rates further to combat inflation.

"The fact that they moved 25 basis points delivered a clear message," said IDEAglobal's Bernal.

"The first part of that message is that the central bank is concerned with keeping inflation expectations under control.

"Secondly, the 25 basis points lift shows that the central bank is not willing to take act aggressively, but rather take on a gradual stance, said Bernal.

"If they had decided to go aggressive, they would have moved 50 basis points," he added.

"They only moved 25 so that implies that gradualism will be the tool of choice of the central bank.

"And that goes in line with the international trends that we are seeing right now," he added.

The Fed has moved in a gradual fashion and other central banks have adopted that strategy, according to Bernal.

Before the hike, local markets priced in a 25 basis points.

Meanwhile, the hike has long-term implications for Brazilian paper.

"In the case of the dollar paper, an interest rate hike tends to be conducive to an additional strength of the real.

"The higher the interest rates in Brazil, the higher the interest of foreigners to invest in the fixed-income market of the country and therefore the stronger the currency," said IDEAglobal's Bernal.

And another important factor is that the central bank is increasing rates with a very important target in mind - to control the inflationary expectations, according to Bernal.

"When you control the inflationary expectations, you should control the rate of return that the market will ask you for the debt. So that in time should reduce the cost of servicing debt for the Brazilian government.

"At this point in time as Brazil is moving pro-actively on the debt front, in my view it will have positive effects on the fiscal accounts because it will contain the rate of return that the market will ask for in investing in Brazilian paper denominated in reals," he said.

Ecuador higher

In other Latin American news, paper from Ecuador continues to perform well, getting a boost from a New York visit by finance minister Mauricio Yepez a couple of days ago.

"And just by him being here is a positive because it reduced the rumors of him leaving the government," noted Bernal.

"And that by definition is a positive for the perspective of Ecuador finally being able to agree to something with the IMF."

The Ecuador bond due 2012 gained 0.15 to 97½ bid while the bond due 2030 added 0.60 to 80.10 bid.

And Bernal added that the Latin American region has profited from high commodity prices and the oil story is a part of that boon.

"The fiscal accounts in Mexico will continue to look very good because of high oil prices.

"Ecuador's situation is becoming palatable at this point in time - thanks in large part to the high level of oil prices, which has allowed for the market to not freak out," he told Prospect News.

"And Venezuela is also enjoying high oil prices because all of the government revenues and a significant portion of the economy is tied to oil."

And the fiscal windfall has lifted Colombia, he said.

"The only country which is a definite loser here is Chile," he added.

In trading Thursday, the Mexico bond due 2008 was bid at 114.85, up 0.05. The Venezuela bond due 2034 was up 1.65 to 97½ bid.

Vitro plunges

Corporate bond prices were flat in Latin America with the exception of Mexico's glass maker Vitro SA.

Its bonds took a tumble, with the bond due 2007 falling six points in early trading to 94 bid, 96 offered while its bond due 2013 lost 6½ points to 85½ bid, 87½ offered.

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