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Published on 6/3/2005 in the Prospect News Emerging Markets Daily.

Emerging market debt slides on slower job creation; market looks to Greenspan for clarity

By Reshmi Basu

New York, June 3 - Emerging market debt initially moved higher in response to slower job growth in the United States, but eventually ended down on a pullback in U.S. Treasuries.

The U.S. economy added only 78,000 jobs in May, the Labor Department reported, coming in at half the level expected by analysts. Initially, the news sent Treasury yields down to 3.8%. But then Treasuries skidded as investors cashed in on the recent rally.

The yield on the 10-year note stood at 3.98% in late trading Friday.

At the outset, emerging market debt took the non-farm payroll numbers very well, according to a buyside source.

"And then it decided that it didn't like them. And it looks like the market...has priced down a quarter or so on the day," he said.

"That got a lot of people thinking maybe the Fed is on hold. You saw the euro strengthen, stocks weaken and bonds rally like crazy. It basically got ahead of itself," added the buyside source

The market had become overextended and then succumbed to profit taking, according to Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal.

"It took a while for the actual non-farm payroll numbers to filter into our market. "

"We had a muted reaction at first and then when the Treasuries...started to unravel, then we saw more of a normal profit-taking type maneuver," he added.

During the session, emerging market prices generally tracked U.S. Treasuries. The Brazil C bond fell 0.562 to 101¾ bid while the bond due 2040 dropped 0.90 to 118.90 bid. The Mexican bond due 2009 slipped 0.20 to 119.60 bid. The Russian bond due 2030 dove one point to 110¾ bid.

4th week of fund inflows

Meanwhile, emerging market bond funds saw inflows of $67.8 million for the week ending June 1, according to EmergingPortfolio.com Fund Research.

This was the fourth straight week of inflows, which has resulted in a return of 1.4% over the past two weeks. The previous week, ended May 25, saw inflows of $63 million.

Clarity hoped from Greenspan

The market may now be headed back to wait-and-see mode, as investors struggle to pinpoint what lies ahead for the Federal Reserve.

Conflicting statements emerged as to whether the central bank is close to wrapping up its tightening cycle.

On Friday, federal governor Edward Gramlich said he did not know whether the Federal Reserve is near to finishing its tightening of monetary policy.

The comments appeared to have disputed statements made on Wednesday by Dallas Federal Reserve president Richard Fisher, who said the Fed was in the "eighth inning."

Asked about Fisher's comments, Gramlich told reporters: "I don't know what inning we're in."

According to Alvarez, the market will be looking for clarity from Federal Reserve chairman Alan Greenspan. He testifies Thursday before Congress on the state of the economy.

"Essentially, Fisher painted him into a corner by saying that we are in the 8th inning," commented Alvarez.

"I think it's on Greenspan's plate to try and clarify that. Otherwise, he may be leaning one way or another in very unfavorable waters," he remarked.

"He needs to make some sort of definition. Otherwise, the market continues to buy into this very low rate scenario, like it did this week."

Until then, the market returns to "wait and see" mode, peppered with potential bouts of profit taking, said Alvarez.

"If you look at prices from a price basis, not a spread basis, you are quite near historical highs, not withstanding today's [Friday] session

"You're at a point range from historical highs, in particular in Brazil, in Colombia - some of the credits that have done really well over the course of the last few weeks.

"People may decide to pull in their horns a little bit before we see something else come out on Greenspan's side," he remarked.

Additionally, the buyside source remarked that his strategy has not changed, but that he is more wary.

"We've had a nice rally in high yield.

"EM has still outperformed. I'm still going to be underweight in emerging markets. "Although after the rally in high yield, I might be a little more cautious in general," he added.

The question of valuation will keep him on his toes.

"The market is very sensitive to what economic growth assumptions you use," he noted.


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