Emerging market debt defiant amid Treasuries' decline; Korea sells $1 billion euro, dollar bonds

By Reshmi Basu and Paul A. Harris

New York, Oct. 26 - Emerging market debt shrugged off a struggling U.S. Treasuries market Wednesday, even as the yield on the 10-year note pierced the 4.60% threshold.

In the primary market, the Republic of Korea priced $1 billion equivalent of 10-year euro-denominated bonds and 20-year dollar-denominated bonds (A3/A/A+).

Back in the secondary, even as prices fell across the asset class, the market showed resilience as spreads narrowed for a second straight session. The JP Morgan EMBI Global Diversified Index tightened three basis points to 250 basis points.

In the previous three sessions, yields on the 10-year Treasury note have blown out by 20 basis points. But even as the 10-year marked a new range, emerging markets remained unbowed, a surprising performance, according to market sources.

The explanation as to why spreads continue to grind tighter is difficult to pinpoint, according to Enrique Alvarez, Latin America debt strategist for research firm IDEAglobal.

Global liquidity and massive amortization and coupon payments in October may underpin the market's resilience, he noted.

Additionally, the market is "either growing more comfortable with the risk that it's bearing or it is making a bet that at some point in time, U.S. Treasury rates will turn," Alvarez noted.

Furthermore, Alvarez said he believes that the market is indeed hedging its bets that the U.S. economy is due for a significant slowdown.

"In turn that's why the market is accumulating positions, thinking that's sort of going to be the medium-term prognosis. Therefore, investors prefer to sit on yield," he observed.

But perhaps noteworthy is that overall high beta names did not under-perform lower beta credits, which says a lot, according to Alvarez.

Normally in an environment such as this one, high beta credits such as Brazil, Colombia and Venezuela would under-perform credits such as Panama and Peru. That did not happen on Wednesday.

During the session, the Brazil bond due 2040 traded in tight ranges, according to a market source. The 2040 bond was spotted at 119.05 bid, 119.20 offered, down 0.60.

Ecuador down on political concerns

Ecuador also ticked lower on political concerns. On Tuesday, congress pushed for a motion to reject the disbursement of the $450 million Latin American Reserve Fund (FLAR) loan, claiming that it unconstitutionally raises the country's foreign debt. The showdown between congress and president Alfredo Palacio's plan to create a constituent assembly is intensifying.

"It seems that he is taking a step back and is hiding behind the social organizations that kicked out [former president Lucio] Gutierrez," commented Alvarez.

"What that means going forward is that things could get a lot nastier on the political front in Ecuador," he added.

A source said that without FLAR money, 2006's financing outlook for the country is questionable, even with high oil prices.

During the session, the Ecuador bond due 2030 fell ¾ of a point to 87½ bid.

Poland lower as talks drag

Meanwhile, political noise pulled down Poland's bonds. Coalition talks between Poland's two biggest parties Law and Justice Party (PiS) and Civica Platform (PO) look closer to falling apart, noted a source. The two right-wing parties are unable to agree on who should be the parliamentary speaker.

The Polish bond due 2014 was spotted down 0.87 to 101.065 bid while the bond due 2017 fell 1.17 to 92.814 bid.

Korea's deal

In the primary market, the Republic of Korea priced $1 billion equivalent of 10-year euro-denominated bonds and 20-year dollar-denominated bonds (A3/A/A+) Wednesday.

The issue is made up of €500 million of 10-year bonds and $400 million of 20-year bonds.

The 10-year bonds priced at 99.055 to yield mid-swaps plus 25 basis points. The tranche priced on the tight end of revised price guidance of mid-swaps plus 25 basis points to 27 basis points.

The 20-year bonds priced at 98.631 to yield Treasuries plus 95 basis points. The tranche priced inside of price guidance of Treasuries plus 97 to 100 basis points.

ABN Amro, Citigroup, Goldman Sachs and UBS Investment Bank managed the sale of the Securities and Exchange Commission-registered bonds.

And Argentina sold $632 million of Boden bonds due 2015 to yield 8¾% Wednesday.

Last month, Argentina canceled an auction of $800 million in 10-year bonds because investors demanded a yield higher than 8.8%. Following the failed auction, the government pursued fundraising efforts with Venezuela, some provincial governments and other decentralized entities, all of which have available cash flow.

But for this auction attempt, the government opted for a different strategy, noted another market source.

The government announced a fixed price for the bonds at $890.85 per $1000 face value bonds. The yield was preset at 8¾% and investors were allowed to place a bid.

The source said that it was widely believed that the government had already found buyers for the issue.

State-run Banco de la Nacion bought $494 million of the bonds.

Alvarez said the price does not reflect the risk investors are willing to take on.

Argentina would have offer a yield in the 9¾% area to place these bonds in an open market, said the source.

On Tuesday, the central bank removed constraints on banks to hold no more than 5% of their net worth in dollar-denominated assets. This meant that more state banks could buy more dollar-denominated Bodens.

Also pricing, Nadra Bank of Ukraine sold $100 million of three-year bonds at par to yield 9½% via Dresdner Kleinwort Wasserstein and UBS Investment Bank.

Out of Malaysia, Southern Bank Bhd. sold $200 million of hybrid tier I perpetual notes at par to yield 6.62% or a spread of 203 basis points more than Treasuries.

UBS Investment Bank was the bookrunner for the transaction.

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