Emerging market debt moves back and forth with U.S. equities

By Reshmi Basu

New York, June 14 - Emerging market debt seesawed Wednesday as it moved in lockstep with equity markets.

The start of the session was quiet ahead of the release of the consumer price index in the United States. The Labor Department reported that core inflation, which excludes food and energy costs, jumped 0.3% in May, above market expectations for a 0.2% rise.

The headline consumer price index came in line with expectations of 0.4%.

After the release of the data, the U.S. stock market was mixed as the higher inflation numbers were seen as providing more ammunition for the Federal Reserve to raise rates at its June meeting.

At first, emerging market debt shrugged off the CPI numbers, according to a trader.

The market had already discounted the fact that the numbers would be bad. And bad they were, noted market sources.

"As equities went higher, we traded better. But then as equities came off, we did. We're still tracking the equity market. Whatever that's doing, we're following along," the trader added.

"No technical reason that we're lower," he remarked.

But then U.S. stocks reversed fortunes in late afternoon, buoyed by a rally in shares of Boeing Co.

At session's end, the Dow Jones Industrial Average was up 110.78 to close at 10,816.92 points while the Nasdaq ended an eight-session losing streak.

That gave some respite to the rest of the markets as well as Latin America, according to Enrique Alvarez, Latin America debt strategist for research firm IDEAglobal.

But overall sources described the session as once again a market with no conviction, with the moves in sovereign debt simply mirrored equities.

Spreads on the JP Morgan EMBI+ index were quoted tighter by seven basis points on the day in late afternoon trade, according to a market source. The EMBI+ was down 0.02% at the close of the session.

"You had two effects: essentially the rebound effect coming from the U.S. rebound in equities and the already absorbed CPI number while on the other side you had the 10-year [U.S. Treasury note] coming off of 5% all the way back to 5.07%," remarked Alvarez.

The bellwether Brazilian bond due 2040 was spotted down 0.10 to 123.05 bid, 123.15 offered.

Both Colombia and Mexico traded down in tandem with U.S. Treasury weakness.

The Colombian bond due 2033 was seen down 0.25 to 127.25 bid, 128.25 offered while the Mexican bond due 2033 fell 0.60 to 105 bid, 105.50 offered. The Venezuelan bond due 2027 was spotted down 0.30 to 119.10 bid, 119.60 offered.

Stoic performance by EM debt

Over the last month, the external debt market has been somewhat stoic in comparison to local markets amid the current turbulence. Emerging market debt has lagged the downturn in local markets.

Most EM countries are raising rates and that coupled with sour local markets is seen as likely to result in slower growth for emerging economies. Last week saw the European Central Bank, South Africa, South Korea and India all raise key lending rates.

"I definitely think the combination of EM central banks raising rates and EM economies slowing down spells increased risk for EM external debt markets, but it will take some time before these dangers play out," said an emerging market analyst.

"EM external debt spreads still reflect an almost perfect outlook for EM fundamentals, even though those fundamentals are about to take a beating when local rates go up, tax revenues fade on weaker economies, and export growth slows down on weaker commodities prices," he added.

"For now, though, the technicals in EM external debt are excellent, especially with the Brazilian Treasury lined up to buy the market on dips, and that will help this market weather any further volatility, at least in the short term."

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