Emerging market debt up on U.S. markets, Mexico's election outcome; Korea Highway to go on the road

By Reshmi Basu and Paul A. Harris

New York, July 6 - Emerging market debt saw a firmer tone Thursday, buoyed by stronger U.S. core markets as well as positive news on Mexico's election front.

U.S. financial markets reversed recent negative sentiment Thursday on the back of mild economic data. The yield on the 10-year U.S. Treasury note fell to 5.18% from Wednesday's 5.22% while the Dow Jones Industrial Average index closed 73 points higher.

The previous session saw selling, but with improved performance of U.S. markets, the overall tone in emerging markets was a little more solid Thursday, according to a trader who focuses on Asian fixed-income securities.

In the morning, emerging markets bonds were higher, emerging markets equities were up and the currencies were pretty strong, noted a sellside source. The source added that there was not a lot of local markets activity.

"The peso is substantially better, at just under 11.09 pesos to the dollar. The closing level on Wednesday was 11.25 pesos to the dollar. That's a big rally in the currency," the source said in the morning.

The trader observed that there was some buying and not much selling.

"We saw five to seven basis points of tightening in the Philippines and Indonesian credit default swaps, which is roughly what was seen in the Latin American names," commented the trader.

Overall emerging market debt saw higher prices. During the session, the bellwether Brazilian bond due 2040 gained 0.75 to 124.50 bid, 124.65 offered. The Ecuadorian bond due 2015 added 0.60 to 100 bid, 100.85 offered. And the Philippines bond due 2025 was higher by 0.63 to 124.125 bid, 124.50 offered.

Issuers waiting for stability

In primary news, South Korea's Korea Highway Corp. is poised to hold a Europe-only non-deal roadshow despite geopolitical jitters resulting from the recent missile tests by North Korea. Deutsche Bank, JP Morgan and UBS are leading the roadshow.

Meanwhile the sellside source said that some pipeline deals are on hold with some feeling as though there might be a window of opportunity about to open.

"We will have to wait until Friday to see how the non-farm payrolls look. Then you might see a small sovereign deal," replied the source.

The trader added that there is reasonable amount of supply that wants to come and that periods of market stability will encourage issuers to try to hit the market.

Calderon comes on top

Conservative Felipe Calderon emerged as the winner in Mexico's disputed presidential election. His left-of-center opponent Manuel Lopez Obrador said he would challenge the results.

During the ballot count, the pendulum swung back and forth between candidates. On Wednesday, Obrador moved to a narrow lead, which hurt local markets. However, Calderon was always expected to come out ahead due to the geographic progression of the recount

Final results gave market-favorite Calderon a razor-thin edge over his opponent. Obrador and his party, the Party of the Democratic Revolution, said they would take the matter to the Federal Electoral Tribunal and he has called for his supporters to rally on Saturday.

"The market seems priced to the belief that the Calderon victory will hold up," observed a debt strategist, who added that a reversal in the outcome would come as an unexpected and negative shock to the market.

The market-friendly results helped Mexican bonds gain. During the session, the its sovereign due 2026 gained 1.50 to 149.50 bid, 151.50 offered.

Cautious optimism, says strategist

Overall, the strategist described the tone as cautious optimism. He added that he is not overly concerned about such issues as North Korea's missile launches, which triggered some unwinding of investor positions Wednesday.

"South Koreans don't seem too terribly concerned about it and they live right next door," he said.

Instead the debt strategist is concerned over the usual cast of culprits, which include the direction of interest rate actions by the Federal Reserve and U.S. economic growth.

He noted that the emerging market asset class has regained some ground from the "pessimistic risk reduction tone of early June."

"We have seen a lot of the most sort of volatile measures, particularly emerging market equity indices make very substantial gains," such as the MSCI worldwide equity index. Additionally, the strategist points out that the Japanese equities market has regained momentum.

"It feels to me like it might be the combination of short covering and people actually putting some risk back," he said, referring to the tone in emerging markets.

Furthermore, the market is bracing for a pause in the tightening of U.S. monetary policy, he remarked. The Federal Reserve may hike rates for the 18th straight time at its next meeting in August, but many believe the current tightening is nearing the end.

"If we're not there, then it's one and done. This is possibly a sort of cycle pause relief rally and that may have some ways to go.

"I think attention should shift relatively soon maybe away from the Fed and back toward specific country fundamentals. And you should see more of a mixed print," he told Prospect News.

But countries that suffer from large current account deficits are still under pressure.

In previous weeks, those countries saw spreads widen as the expectation of higher global rates raised investors' worries about credits such as South Africa and in particular Turkey.

Turkey's spreads kicked out on concerns over its ability to access financing in a more risk-averse world. Over the last two weeks, Turkey's central bank has made moves such as an intervention to sell dollars as well as an emergency rate hike to shore up the foreign exchange market.

"Clearly the currency is not as overvalued as it was," the strategist said.

"If you looked at what happen, you have a devaluation and a monetary tightening, which are kind of the classic monetary policy reactions to excess domestic demand [that] the rest of the world in its infinite wisdom concludes one fine morning that it does not want to finance," he observed.

Nonetheless, Turkey has to understand that belt tightening is necessary. And if it does, everything will be fine, he said.

"The mission here is to protect reserves, take some steam out of domestic demand and higher rates. And a weaker exchange rates does both of those things," he concluded, adding this serves to rebalance the economy by tempering importers' excitement and raising exporters' enthusiasm.

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