Emerging market debt up on tame inflation numbers; Asia's markets on the defensive

By Reshmi Basu and Paul A. Harris

New York, May 18 - Emerging market debt gained momentum on tame inflation numbers in the United States, which sparked a rally in both the Treasury and equities market.

"The market is much better bid today [Wednesday]," said a trader. "After CPI came in benign, we kind of traded up all day."

On Wednesday, the Labor Department reported that the consumer price index rose 0.5% in April, but core CPI was flat for the month, damping fears that the United States faces a slowing economy and higher inflationary pressures.

"Everything was up across the board - no major lagging or major out-performance," the trader added.

The Brazil bond due 2040 opened the session at 113.35. It was quoted at 115.18 bid, up 1.83 points in late afternoon. The Russia bond due 2030 opened the session at 107.28. It was spotted at a bid price of 107.90, up 0.62.

He said that volumes were decent with locals and big investment firms taking part in two-way flows.

He also attributed Wednesday's firmer tone to short-covering.

The CPI data added momentum to an already rallying U.S. Treasuries market, which has gained traction in recent sessions on fears over hedge funds' exposure to automakers General Motors Corp. and Ford Motor Co.

The yield on the 10-year note fell to 4.068% from 4.117% Tuesday.

But it will obviously take more to snap emerging market debt from its current cautious tone, according to an emerging market analyst.

"I think it will take continued generous liquidity conditions and decent U.S. economic growth," he said.

"Both those things seem to be happening - Treasury rates are lower today [Wednesday], and most (but not all) of the recent U.S. macro data shows the economy doing relatively well," he added.

Treasuries due for correction, says investor

However, the Treasury market's flirtation with three-month low yields may be fleeting, according to a buyside source.

"Treasuries below 4.10% - I think that's a pretty good sign for our market - problem is that I don't it's going to stay there," the source said.

The source warned that the Treasury market is due for a market correction, given how tight the current level is.

"I still think we are going to see volatility over the summer months."

Credit markets, in particular high-yield, will trigger the sell-off, remarked the buyside source.

"I think there's still some GM and Ford effects that haven't materialized yet and we're going to see that in the next months. Volatility should pick up."

Nonetheless, emerging market debt needs to see the correction, said the source.

"That also would trigger people to put some money to work.

"And real money accounts, which are kind of the main investor type that supports this asset class, have been sidelined.

"So far, if we see a spread widening, then there will be value again and we will see buying on that, so I think that will be good," commented the buyside source.

The source added that emerging markets are fairly priced at the moment

"If you look year-to-date, they outperformed all of the other credit markets.

"If you were following all the other asset classes, you would probably think that we're bound for a debt correction that has hit everybody else," the source noted.

Asian markets on defensive

Asian markets are on the defensive, according to a trader of Asian debt securities

"The long end of the Philippines curve has bounced close to a point. The Asian high-yield market, on the other hand, has been under quite a lot of pressure over the past couple of days," said the trader.

He added that the best thing that could be said about Wednesday's session is that there is not as much pressure.

"Spreads are certainly doing better. But stuff has not been beaten up too badly, anyway, outside of a couple of specific credits."

Meanwhile, the new issue from Korea Highway Corp. has gained slightly in the secondary. On Tuesday, the state-run issuer priced $500 million of 10-year senior fixed-rate notes (A3/A-/A) at 98.938 to yield a spread of 115 basis points more than Treasuries via Citigroup, JP Morgan and UBS Investment Bank.

The new deal was spotted at 114.10 basis points in trading Wednesday.

"What we saw with this Korea Highway deal is kind of the new rule for supply right now: you have got to come with a concession to get deals done," remarked the trader.

"It's not like before, where you came out with cheap price talk and then tightened it if the demand was there.

"'Concession' is where it's at now for a while.

"And secondary levels are going to react to where the supply is, which is basically what happened with the Korea Highway deal.

"But given the circumstances, getting anything done was pretty constructive. And it's definitely starting to feed through into secondary spreads now."

New issue activity

There was better buying of Korean paper during the morning, partly supported by the fact that the Korean highway deal got done, remarked the trader.

Meanwhile in the primary market, South Korea's National Agricultural Cooperative Federations (NACF) will price $250 million to $400 million offering of 10-year lower tier II bonds on Thursday.

Final size is to be determined during the Asian morning session.

The bonds are talked at mid-swaps plus 100 basis points, and are expected to price on Thursday.

The 10-year bonds are non-callable for five-years. There will be a 100 basis points step up if the securities are not called on the first call date.

The deal is multiple-times oversubscribed, according to sources.

Barclays Capital, BNP Paribas and JP Morgan are the bookrunners for the Regulation S offering.

NACF previously postponed the offering on March 16, citing market condition.

Nuclear test threat impacting spreads?

Meanwhile the debate continues as to the impact of a possible North Korean nuclear weapons test.

One trader told Prospect News Wednesday that such an action could have a dramatic impact on emerging markets, which are already on the defensive.

Meanwhile a sellside source said that the geopolitical noise from Pyongyang appears to already be priced into the market, and that investors who buy Korea are well aware of those risks.

On Wednesday another trader of Asian debt securities took the middle ground.

"It is always surprising how resistant Korea is to geopolitical risk," the trader said, adding that geopolitical risk has been there for a long time.

"This [nuclear test] issue is definitely in the back of peoples' minds," the trader added.

The trader also said that since the news of the North Korean reactor shutdown on April 18 -a step that would allow removal of materials for bomb-making - Korean credit default swaps are 10 to 15 basis points wider.

"That's partly geopolitical and partly just a function of the general market," the trader added, estimating that the split between those two factors is likely 50-50.

In the "Special Report on the Shutdown of North Korea's 5MW(e) Nuclear Reactor," published on April 28, Daniel A. Pinkston, Ph.D., director of the East Asia Nonproliferation Program at the Center for Nonproliferation Studies, Monterey Institute of International Studies, and Andrew F. Diamond, program director of the East Asia Nonproliferation Program at the Center, asserted that North Korea likely shut down the reactor for one of three reasons.

"First, the shutdown could be due to a malfunction or technical problem. Second, the reactor could have been shutdown to raise the stakes in the nuclear standoff, bolstering Pyongyang's demand for bilateral talks and security assurances from Washington. The third alternative is that the reactor has been shut down in a determined effort to reprocess the plutonium from the spent fuel and to produce nuclear bombs."

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