Early gains slip away as credit fears rise again; Argentina, Venezuela lead drop; Turkey strong

By Paul Deckelman and Aaron Hochman-Zimmerman

New York, Aug. 20 - Emerging market bonds initially moved up on Monday, riding the momentum from Friday's session, when they rose after the Federal Reserve stepped in to try to calm jittery financial markets with an unexpected 50 basis point cut in its discount rate. But as the warm afterglow from that step began to fade, and there was renewed investor concern about the credit crunch arising from the U.S. subprime mortgage lending meltdown, EM bonds gave up their early gains and moved lower.

The volatile bonds of Argentina and Venezuela, which had led the market up during Friday's post-Fed bounce, were leading the way back downward on Monday. But a research report suggests that things might not be as bad as perceived in Argentina, and some buying opportunities have opened up. Brazil's bonds were also lower.

Outside of Latin America, Turkey's bonds were seen better, helped by strength in its currency unit, the lira. Investors also pretty much ignored the preliminary round of balloting in the selection of the country's president by Parliament. South Africa's bonds built upon Friday's gains.

There was little activity in the international primary markets Monday, although some expressed hope that conditions could be improving.

But in trading renewal of the debt investor fears about the impact of the U.S. credit crunch, especially during the North American trading day, drove Treasury yields lower, particularly on the shorter end of the curve, with the 3-month Treasury bill's yield plummeting some 66 basis points on the session - the biggest flight to safety seen since the day of the October 1987 stock market crash, even eclipsing the fall in yields on the first session back after the 9/11 terrorist attacks. Meantime, the benchmark 10-year issue's yield came in 5 bps to 4.62%.

The rise in Treasuries and the corresponding fall in EM bonds drove spreads between their respective yields - the key measure of investor risk aversion - still higher. According to the widely-watched JP Morgan &Co. EMBI+ index, the average spread was 4 bps wider at 289 bps.

Argentina, Venezuela underperform

Argentina's sovereign paper gave up its early gains - the benchmark dollar-denominated 8.28% bonds due 2033 were up more than ¾ point initially, cruising higher on Friday's momentum, but by the time things had wrapped up for the day in the Americas, those bonds had lost more than half a point, finishing quoted at 79. The yield on the bonds rose 7 bps on the day.

Fellow high-beta credit Venezuela was also helping to lead the early upsurge, before that fire fizzled out. Its 9¼% global bonds due 2027 ended quoted down a point at 96 bid.

Analysts have noted that besides being buffeted by the same winds that were seen affecting emerging market credits generally, Argentina, Venezuela and the third member of the high-beta trio, Ecuador, have also been impacted lately by investor angst over political turmoil in each of those countries - problems ranging from the controversy in Argentina over the accuracy of government-reported inflation data, and the impact on that country's economy of corruption allegations and even power shortages, to the efforts by the respective presidents of Venezuela and Ecuador, Hugo Chavez and Rafael Correa, to increase their authority over the countries' traditionally autonomous central banks.

Argentina rout seen overdone

Argentina has been the worst EM performer this year, with both its sovereign bonds and its corporates being hard hit - but the downturn may have been overdone, according to analysts at Standard Bank Group.

In a research note on Monday, they noted that "news of power shortages in July, continued meddling with reported inflation rates, and political scandals all conspired to increase investors' frustration with Argentina. In the current environment, and given Argentina's history, it was just too much bad news...with no outlook for good news on the horizon.

"However, none of these developments should have been a surprise," since the power sector there "has been in a state of crisis for several years." They also cited the fact that the markets knew all about the reported statistics manipulation for some time, adding that "we do not believe that anyone thought that this government was corruption-free."

For all of the negative noise being generated there, the Standard analysts pointed out their belief that there is no imminent financial crisis looming in Buenos Aires - especially with between 30% and 40% of the funding needs from the upcoming years expected to come from Venezuela, which is acting as a banker and patron to Argentina, and the rest likely to be "fairly easily" generated internally.

The analysts wrote that the country's well publicized problems have especially spooked investors regarding its corporate bonds. "With the exception of the very, very best corporates, investors have literally dumped Argentine corporate bonds. In our view, there has been little or no discrimination between corporate credit quality in the sell-off."

They noted that the best performers among Argentine corporates have been the bonds of Mastellone Hermanos - "the most leveraged company in our coverage universe."

Standard said that the recent sell off has created some buying opportunities that are "too compelling to pass up." While it generally recommends that investors "stay as short as possible," it also urges that they "keep an eye on some medium duration issues" for possible opportunistic buying, including Banco Macro, Transener, and the BHIP notes due 2016.

Brazil ends slightly easier

Elsewhere in Latin America, Brazil's widely traded bonds were also lower, but not to the same extent as the volatile Argentine and Venezuelan issues got hit.

The country's benchmark 11% dollar notes due 2040 surrendered early gains to push below the 130 mark by the close, while its real-denominated zero-coupon bonds due 2008 likewise reversed course, with their yield ending up 2 bps at 11.40%.

South Africa consolidates gains

Outside of Latin America, bonds had been higher during their local trading sessions, hours before the Fed glow began to fade during the U.S. session.

One gainer was South Africa, whose bonds were able to consolidate the gains they had posted on Friday, after the Fed move gave a worldwide boost to financial markets.

The key security, the R153 bonds due 2010, was yielding 9.210% at the close of the local trading day, down from 9.260% previously; the longer-term R157 due 2015 firmed to a yield of 8.44%, down from 8.49% before; and its short-term R146 bonds were bid at a yield of 9.495%, in from 9.520% previously.

Turkey investors ignore balloting

In Turkey, government debt advanced for a second straight session, helped by a stronger lira and an easing, at least temporarily, of the political tensions brought about by Islamist politician Abdullah Gul's efforts to be chosen as the country's next president, a prospect which has raised the hackles of secularists in Turkey's society, including its military leaders. Gul, currently serving as the foreign minister in the AK Party government, is the party's choice for president, who is chosen by Parliament, but he failed to gain the required votes in Monday's balloting; another vote is slated for Friday. Gul is expected to be chosen by the third round of voting on Aug. 28.

Even so, the yield on the government's benchmark bonds due 2009 fell to 18.29% from Friday's levels at 18.71%, although the yields on Tuesday-dated trades did creep back up a little, to 18.33%.

The lira meantime has gained on the popularity of so-called "carry trades," in which investors buy the high-yielding currency using funds borrowed more cheaply in other currencies, such as the yen. Turkey's interest rates, at over 18%, are the highest in Europe and among the highest in the world.

Local activity in primary

In the primary market volatility let up enough for one local issuer to price and another to announce plans for a new transaction.

Israel's Matrix IT Ltd. was able to price $60 million, and India's Corporation Bank said it intends to sell Rs. 200 billion.

"It feels better," said an emerging market syndicate desk official about a day that ended with the VIX Index down 3.66 to close at 26.33.

"A few more days of this may be good news," the official said.

An emerging markets strategist said that the recent bottom fishing in the U.S. equity market has allowed for an improved sentiment around emerging markets and kept them from falling off of the cliff.

In the short-term a rebound may be on the way, the strategist said.

A bounce may cause investors to begin profit taking, but the wise long-term investor will use the opportunity to move money to higher grade, more liquid credits, the strategist said.

Another market source said there is cause for optimism, but the payoff may still be three to six months off.

Equity markets have traditionally responded well to rate cuts by the Federal Reserve Bank, the source said, but benefits often do not present themselves until the third or even sixth month after a cut.

Matrix sells, Corporation plans

Israel's Matrix priced its $60 million six-year notes at a fixed rate of 5.15% linked to the Israeli Consumer Price Index, according to a press release.

The bonds will be repaid in four equal installments between 2010 and 2013.

Proceeds from the sale are expected to be used to expand the company through global mergers and acquisitions.

The notes sold by the Herzlia Pituach, Israel-based information technology company were oversubscribed by approximately $120 million, the press release said.

"The fund raising was successfully completed despite the fact that worldwide markets have been dropping in the past couple of weeks," said chief executive officer of Matrix's parent company Emblaze, Guy Bernstein.

Elsewhere, India's Corporation Bank will sell Rs. 200 billion worth of tier II bonds.

The bonds will be the second offering from a Rs. 500 billion program. Rs. 300 billion was issued on March 24, 2006.

The new bonds are expected soon, but exact timing is not yet available. The issue will be sold at "an appropriate time," according to a press release.

The government controlled investment and retail bank is based in Pandeshwar, India.

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