Fed cut rally fizzles, emerging markets trades lower; Argentina, Venezuela plan $1.2 billion Bono del Sur

By Aaron Hochman-Zimmerman

New York, Sept. 20 - Emerging markets slowed its pace Thursday after running ahead in the previous two sessions on the liquidity injected by the Federal Reserve Bank.

The market, which some think had been too excited for its own good, stopped to catch its breath Thursday.

"It's going to be volatile through October," an emerging markets portfolio manager said.

"We're in wait and see mode on earnings and economic releases."

There are questions lingering over where the market is headed, but "my sense is that the market is probably fine," he said.

"We came too far, too fast," the portfolio manager said, adding: "The Fed move is going to be seen as a positive on the margin, maybe we just went too far."

The boost given the market by the easing of benchmark lending rates initially inspired a lot of hope, but many feel it may have not been enough to fix the economic problems in the United States.

Even Federal Reserve Bank chairman Ben Bernanke, in his statement to the House Financial Services Committee said: "Recent developments in financial markets have increased the uncertainty surrounding the economic outlook," according to his written statement.

Chairman Bernanke reassured the committee that the Federal Reserve "will act as needed to foster price stability and sustainable economic growth."

Shortly after the 50 basis point rate cut, bonds followed stocks upward, but even stocks turned around Thursday. The Dow Jones Industrial Average fell 48.86 to end at 13,766.70. The Nasdaq Composite Index ended down 12.19 to close the day at 2,654.29.

The dollar also has fallen against many currencies and finished at 1.406 against the euro.

To some degree the positive response to the cut is "downplaying some of the risks that still remain," an emerging markets analyst said.

But some believe the Fed did the best it could have, given the state of the global and U.S. economy.

"I don't think the Fed is short sighted," said Alberto Bernal, a fixed income research analyst with Bear Stearns, commenting on whether the Fed was influenced by issues surrounding moral hazard.

The Fed has more information than the average investor, and it understands what may affect the real economy, Bernal said.

As the dust settles after the rate cut and the brief rally that followed, there are still plenty of safe bets in emerging markets.

"Everyone yielding more than the U.S. becomes more interesting," Bernal said.

Looking at emerging markets from a perspective beyond the events of this week, the analyst said that "there are structural improvements across EM," and "things are clearly improved relative to the past."

Despite headlines from Northern Rock which demonstrate a lack of credit availability, "countries in EM with better external positions and less internal pressure are in a better place," the analyst said.

Still plenty of investors are waiting to see calmer waters before committing any liquidity. The accepted measure of market volatility, the VIX index, ended the day's session higher again. An additional 0.42 points brought the finish to 20.45 points.

Still unsure of which direction to head, emerging markets as a whole tightened. The JP Morgan EMBI+ index was seen with a spread 190 bps, down 11 bps from its previous close. The index measures the amount of yield necessary for investors to own emerging markets debt.

LatAm watches rally fade

Latin America, which has enjoyed a slight lift from the additional liquidity in the market, should continue to retain its status as fertile ground for investment, even as prices drop in the short-term.

"It reduces the cost of funding for every country," in addition to corporates as well, Alberto Bernal said about the Fed rate reduction.

Higher yielding Latin American assets will become more interesting going forward, Bernal said, as the reduction of the rates "will give a boost to high-beta credits."

Brazil has battled the specter of inflation, but remains one of the darlings of emerging markets.

"Brazil is a very good story," Bernal said.

The real has made gains against the tumbling dollar, although some worry that a lack of liquidity may throw gas on the fire of inflation. The real closed at 1.881 Thursday, weaker from 1.864 Wednesday.

The highly-traded Brazilian 11% sovereigns due 2040 were seen trading at 132.60, off from Wednesday's close of 133.90.

Argentina has battled headlines about its monetary policy, and those worries continue.

"I wouldn't buy Argentina," a market analyst said.

"The macroeconomic policies are unsustainable ... The underlying economic policies are inconsistent over time," the analyst said.

Argentina's high-beta 8.28% notes due in 2033 dropped off to 90.25 from Wednesday's 91.50 close.

Even for its poor performance at times, Latin America still holds great promise for many investors.

"Resilience was shown during the downturn and everyone will be comfortable maintaining or adding positions in these countries," Alberto Bernal added.

Asia shows flexibility

Asian issuers have followed the rest of emerging markets through this week's brief frenzy to its more recent lethargy, yet over the long term Asian issues been more stable than assets in other sectors.

Asian credits have not been dragged through the mud of the U.S. subprime crisis and have remained liquid enough to stay out of the fire of the credit crunch.

"Asian [monetary] policy gives them greater flexibility," an analyst said.

All of the major countries except India and Vietnam are running surpluses, the analyst said.

The surpluses offer them the leeway to adjust policy should downside risks materialize, the analyst said.

Of course, all of emerging markets are plagued by rising oil prices, the analyst added.

Indonesia's benchmark 6.375% notes due in 2017 were seen trading at 104.25 Thursday.

South Africa losing ground

South Africa's minor rally seems to have run out of steam as well. Inflation worries and controversy over monetary policy have slightly weakened the country's sovereigns.

The South African R153 notes finished at 9.15%, off from its close Wednesday at 9.10%. But the long-term R157 bonds managed a gain on the day. They ended trading at 8.48%, just up from their previous close of 8.45%.

The rand fell from its close at 7.041 to end at 7.046 Thursday.

Primary skips on rally

In the primary market, the optimism which came on strong after the rate reduction began to wane along with the trading rally.

Venezuela and Argentina announced plans for another Bono del Sur, this time for $1.2 billion.

On Aug. 17 the two countries pulled a $1.5 billion add-on in three $500 million tranches.

One market analyst remained optimistic about the primary market in general.

"Those markets are reopening," the analyst said, but market watchers still have not seen a strong resurgence in the pipeline.

"Uncertainty is the key issue here," Alberto Bernal said about market volatility's role in keeping up investors' anxiety over new issues.

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