Brazil's troubles spoil emerging market debt; oil prices touch $67 per barrel; Peru's new crisis

By Reshmi Basu and Paul A. Harris

New York, Aug. 12 - Emerging market debt came under attack again Friday as Brazil appeared unable the shake off the ongoing political corruption scandal.

However, an afternoon national address by president Luiz Inacio Lula da Silva had a calming effect on Brazil's financial markets late in the session, said sources.

Since the beginning of the "bribes for votes" scandal in Brazil, Friday tends to see increased selling from locals in case any of the big news magazines publish negative news on Saturday, according to a sellside source.

"And that's where a lot of the political headlines get stirred up," said the source.

"So the locals have had a tendency to sell on Friday and buy back on Monday if nothing happens."

Volatile Brazil

Brazilian bonds have definitely been volatile for the past few days, remarked sources.

In a major blow to Lula, the Brazilian senate passed an increase to the minimum wage late Wednesday night that could cost the country R$ 12 billion over the next year.

That headline drove down prices Thursday and remained a concern leading into the weekend, said the sellside source.

With such an illiquid market, one piece of bad news can have an exaggerated effect, remarked sources.

"I think there were people who were looking for a little volatility on a chance that it might turn things around a little," replied the sellside source.

The bill will next move to the lower house for approval. And if passed, Lula may then choose to veto the bill, which may be seen as a politically unpopular move.

If enacted, the bill would increase the monthly minimum salary to R$ 384 from R$ 300.

Sources added that the passage of the bill has nothing to do with the ongoing corruption scandal in Brazil, but they do see it as a political maneuver.

"It's election year politicking," said the sellside source.

"And the opposition party decided, wouldn't it be interesting to put Lula in the position where he has to veto a minimum wage increase. It just makes the guy look unpopular or anti-populist," said the source.

Another source agreed, calling it a brilliant political move by the opposition.

"It traps Lula in a no-win scenario," according to Enrique Alvarez, Latin America debt strategist for think tank IDEAglobal, who added that a veto by Lula will mar his popularity.

"You look terrible because you campaigned on a populist platform and it erodes your support some more."

"It's a lose-lose proposition for him. And it's a masterfully done by the opposition."

Lula addresses nation

Meanwhile, president Lula apologized to the nation over the allegations of corruption, which has battered his Worker's Party. But he denied any knowledge of the "bribes for votes" scandal, during a nationwide televised address Friday.

"I feel betrayed by unacceptable practices that I never new about," he said during the address.

"I am not ashamed to say that we have to apologize," he said. "I want to tell you, don't lose hope. I know you are angry. I certainly am as angry as any Brazilian or more."

Alvarez said the address had a soothing effect on Brazil's financial markets.

"The Bovespa was down pretty severely in the early going," he said.

"It was down about 1½ to 1.7%. And it sort of came back and halved its losses.

"He repeated that he did not have anything to do with the funding scandal that's in progress," noted Alvarez.

"He denies everything, but I think the market is becoming progressively less convinced by what he is saying."

But Alvarez cautioned that investors should not read too much in Brazil's upturn. During Lula's address, the U.S. Treasury market regained strength, which helped sovereign prices rebound.

"Debt prices were depressed early and ended the day essentially unchanged, although there were losers on the long-end," he said.

During the session, the Brazil bond due 2040 fell 0.30 to 117.95 bid.

"We've been holding up so well," remarked the sellside source.

Looking ahead, the source said that investors are cautious, but overall are constructive because of technicals. The source added that the belief is that Lula will survive all of this. And there is nothing within the asset class to bring down the market.

"We are due for a little bit of a correction. I think people will welcome the chance for a little breather. I think people still have cash."

Meanwhile that desire to put cash to work helped state-run National Power Corp. The debt-laden Philippines utility on Thursday sold an upsized offering of $300 million in six-year floating-rate notes (B1/BB-/BB) at par to yield three-month Libor plus 425 basis points.

"I think it got a better reception than the last time that Napocor tried something but I think that's just a reflection of the fact that people have cash and they are having trouble spending it," remarked the sellside source.

"If you offer somebody 125 or 150 over the sovereign, for something that is sovereign-guaranteed - and it's only five years - a lot of American accounts probably looked at it and thought 'I'm always going to own some Philippines. I'll take this.'

"My sense is that the locals, who are normally good buyers of Philippines deals did not buy this one."

Bear Stearns was the bookrunner for the Rule 144A/Regulation S transaction.

Oil touches $67 a barrel

In separate news, oil prices had little impact on oil producers, even as they stabbed $67 per barrel on Friday, noted Alvarez.

"I think what is happening is that the market is caught between the two scenarios that the Fed is also pondering. Where are oil prices going to have more impact: on growth or on inflation?

"And they are siding on the side of growth. If that means reduced growth, that means the Fed will have less impetus to continue on their track of increasing interest rates," remarked Alvarez.

He added that U.S. Treasuries are betting on that, and hence, so is Latin America.

"Are they going to be right? I don't really think so."

Light sweet crude for September delivery gained $1.06 to close at $66.86 a barrel Friday.

For the session, the Ecuador bond due 2030 was quoted at 88 bid, down half a point. The Venezuela bond due 2027 gained 0.30 to 105.55 bid.

"Oil producers haven't really been out-performers," noted Alvarez.

"Venezuela has done a little better here and there. Ecuador has good days and bad days.

"Venezuela was above the market today [Friday]. But again there have been very skittish volumes for the last seven to 14 day

"It's difficult to tell if it's real out-performance or the way people are pricing assets."

Peru's new crisis

Peruvian president Alejandro Toledo named controversial Fernando Olivera as his foreign minister Thursday. In protest, prime minister Carlos Ferrero stepped down. Toledo then asked his entire cabinet to resign.

"It was a major stumble to name Olivera as chancellor," remarked Alvarez.

"He has one of the worst reputations in a politics. He has been involved in a number of different investigations, where he has initiated those against other congressmen and never found anything relevant in the end."

Alvarez said the appointment takes away some stability in the political environment as well as injects uncertainty, which was unnecessarily added.

However, economy minister Pedro Pablo Kuczynski said he would stay on.

During the session, the Peru bond due 2008 was down a quarter of a point to 109 bid.

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