Emerging market debt higher; no Russian eurobond issuance in 2004

By Reshmi Basu and Paul A. Harris

New York, June 4 - Emerging market debt traded higher Friday as investors tightened their short positions following the release of U.S. payroll numbers.

Although a little stronger than expected, the jobs data was not taken as indicating the Federal Reserve will have to move more aggressively than investors have been expecting.

Emerging markets debt appeared to be happier in response. The JP Morgan EMBI plus index tightened 15 points by midday. The Argentina component tightened by 72 basis points. And Turkey and Ecuador were slightly tighter.

Meanwhile in primary action, Slovenian power producer Slovenske Elektrarne priced a €200 million 5 5/8% bond issue (BBB-) at a spread of mid-swaps plus 150 basis points on Friday. Citigroup and ING ran the books.

The company is headquartered in Ljubljana, Slovenia.

U.S payroll data eases investor worries

The U.S. Labor Department said 248,000 non-farm payroll jobs were added in May, surpassing economists' expectations of 216,000 new jobs.

While those numbers were strong, they were not spectacular - hinting that the Federal Reserve's tightening of monetary policy would be measured, but no more, in the months to come.

"The key to EM investors isn't so much the level of U.S. interest rates but the direction," said an emerging market analyst."

"If EM investors begin to expect that 10-year U.S. rates will remain stable for the next several weeks, they will begin to buy, assuming that stability in U.S rates will keep EM volatility low for a while."

However, some investors have said that the Federal Reserve has been too slow to act, given that at some point in the year job growth could be very strong. And the Federal Reserve may be playing catch up in 2005.

"I'm surprised that the market thinks that the Fed will close the year with 1¾ or 2% fund's rate, and that that would be reasonable," said Steve M. Hope, managing partner of Outrider Management.

"I think if they react at that speed, the markets will be extremely disappointed by the end of the year.

"The bond market will be extremely nervous about what the Fed is doing and its implications for longer-term inflation," added Hope.

Those jobs numbers reinforce that the Fed should be moving faster than what the futures have priced in. For instance, interest rate futures show 2.1% for December, according to Hope.

"They should try to get to fairly neutral right up front, if not by the end of the year then by the first quarter of next year," said Hope.

"If that means 3%, then raising rates a quarter of a percent at every meeting is not going get you there.

"It seems to me that they ought to raise 50 basis points in June. I think they should. I don't know if they will," added Hope.

With the U.S. economy strengthening, a sell-side source said that from an economic fundamentals standpoint, one could argue that higher risk areas like high yield and emerging markets are safer during an economic rebound.

"On the other hand, from a technical standpoint there was a lot of money in high yield and emerging markets because of the carry trade, that money pulls out," said the source.

Right now the question weighing on investors' minds is how much of that carry trade has been erased and how much is yet to be reversed?

"I don't think anyone really knows the answer to that," said the sell-side source.

Some have suggested that 80 to 90% has been removed from the market.

"Certainly it does seem that a lot of the leverage is out of the market.

"And during the past week or so it has seemed as though it's been tougher for people to try to push the market down," added the sell-side source.

"The pain trade is to the downside. In general the market has held up.

"But the last time Brazil hit 91 it started to come off again, as though people were taking profits there or putting on new shorts.

"We just have to see if maybe we can gap up higher than this now," the sell-side source told Prospect News.

In secondary trading Friday, the Brazilian bond due 2040s was up 1¼ point to around 91 at midday.

The Brazilian component of the JP Morgan Index was 25 basis points tighter at midday trading.

Emerging market debt on uptrend

As the market appears to be rebounding, defensive investors' cash may be hurting them, prompting them to put it to work and helping drive prices up.

"They are seeing their withdrawals slow down," said a source.

"And they may have positioned themselves in heavy cash, anticipating withdrawals that now may not happen."

Against that background, investors are now recycling money into the market.

"And the locals are sort of flush with cash and are not sure where to keep it," added the source.

Despite plenty of cash, investors are not hungry for new deals.

"It's been a strange market like this for six months in that you have a market bouncing along at the top with very low yields," said Outrider's Hope.

"Yet nobody wants to issue and the market doesn't have an appetite for new issuances," he added.

Hope said that emerging market bonds have been getting more expensive in the last four weeks since they bottomed out last May.

In the last three and a half weeks, the JP Morgan EMBI Index has gone from 260 to 272.

"Over a three and a half week period, it's gone up 3½%," said Hope.

Dedicated funds lose $105 million

A source said that the latest weekly funds flow numbers are mixed: dedicated emerging market debt mutual funds saw outflows for a fifth consecutive week, with a $105 million outflow for the week ending June 2, as reported by EmergingPortfolio.com Fund Research.

High yield funds saw a $565 million inflow during the same period, according to AMG Data Services numbers, the best week that the funds have seen so far in 2004, which has seen approximately $8 billion of outflows since Jan. 1.

Meanwhile, international debt funds saw their best fund flows since early April: EmergingPortfolio.com reported $124 million of inflows to international debt funds, an improvement over the previous week's $36 million outflow.

Russia says no more eurobonds in 2004

Among issuers not coming to market is Russia.

Vice prime minister Alexander Zhukov said the nation will not issue eurobonds this year at a Moscow press conference.

The decision not to issue is a reflection of Russia's fiscal picture.

In response Banc of America Securities upgraded its recommendation on Russian sovereign debt to a modest overweight from market weight. In the bank's "Situation Room" daily report, analysts Callum Henderson and Dwyfor Evans noted that Russian had been planning up to $3 billion of new issuance this year.

"Nevertheless, certain issues loom - oil price trajectory, lack of progress in banking reform - tempering our enthusiasm somewhat and leading to the 'modest' part of our recommendation," the analysts wrote.

Outrider Management's Hope observed that Russia has no need to sell bonds at present.

"If we [Russia] could borrow at 6% for 10 years, maybe we would just to create a nice benchmark for our corporates, but we don't need to," said Hope of the decision.

Russia has a good curve for corporates to price off, according to Hope.

"They don't need to come to market. And if they issue, it would only be an opportunistic exercise or to help their corporate sector," he noted.

Venezuela recall referendum

In Venezuela, opposition forces are calling for the recall referendum aimed at left wing President Hugo Chavez to be held before Aug. 19. Under the constitution, if Chavez loses the referendum, elections would take place within 30 days.

"The referendum is set for Aug. 15. And if it happens after Aug. 19, people expect that Chavez will ultimately just end up finishing his term," said the sell-side source.

"A lot of people say the opposition is so splintered that Chavez could win. And he does have the ability to spend a lot of government money."

Brazilian sovereigns rally

Sovereigns are rallying based on a better overall mood in the Brazilian market.

Meanwhile there is low volume in emerging markets corporates, with locals thought to be out of the market.

Another source reported seeing demand for Petrobras Energia and Telefonica bonds.

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