Emerging markets in predictable and tame gains; investors question rally's life-span; primary still unmoved

By Aaron Hochman-Zimmerman

New York, Sept. 19 - Emerging market debt reacted well and stayed close to the script in trading Wednesday after the Federal Reserve's rate cut the previous day.

"EM is reacting exactly as expected," an emerging markets strategist said.

"[EM is] moving higher with external markets, particularly U.S. equities," the strategist added.

All market sectors posted general improvements on what was described as "a strong day," by an emerging markets strategist who specializes in emerging Europe.

"Looking across the board everything is green, not red," he said.

The strategist admits it is difficult to tell how long the rally may last, but at least for now "investors are generally underweight" and "are looking to add [risk]."

Optimism was easy to find, but there are still questions in the air. Many feel the cut was a quick fix while the problems are larger and longer term.

The real economy may already be showing signs of fatigue and the unpredictable nature of worldwide monetary policies may "ultimately render rate cuts less effective," an analyst said.

Treasuries, money markets and equities may have enjoyed the bump resulting from the Fed rate cut, but long-term bond investors may not have been so fortunate, a market source said.

The dollar also suffered loses on the news as commodity prices were again on the rise, the source added.

Another market source took the view that the larger than expected rate cut proves the Fed is "sufficiently worried" about the economy to place those worries above concerns about moral hazard.

In addition, the U.S. housing market has done nothing to improve and the U.S. labor market continues to see negative data, the source said.

As a consolation, chairman Ben Bernanke and his colleagues at the Federal Reserve have proved they are willing to act boldly to deal with crises, the source added.

As an asset class, emerging markets generally performed well in trading Wednesday even though there were some losses were mixed in with the good fortune. JP Morgan's EMBI+ index was seen at a spread of 211 bps, down 12 bps from Tuesday's close. The index measures how much yield investors require in exchange for holding emerging markets debt.

Volatility also felt better Wednesday. The VIX index which measures market volatility dropped below 20 points for most of the day, but finished down only 0.32 to end at 20.03.

Even as the VIX index is heading down, an emerging markets analyst said that the effects of volatility will remain in emerging markets.

Any gains posted in the days and weeks following the Fed cut will probably normalize, and the rally will have run its course by the end of the year, the analyst said.

Turkey, Kazakhstan lag

Emerging Europe's rally has been accompanied by the Bank of England bailout of lender Northern Rock and news of a German economy beginning to slow.

In Turkey the government has been considering a 10% hike in consumer electricity prices which has caused some to worry about inflation and general sentiment, a market source said. Electricity prices were already increased by 25% during the fall of 2006.

Despite the worries, the source believes that the concerns over the Turkish economy are exaggerated.

Nonetheless Turkey's sovereigns due 2016 dropped to 100.75 on Wednesday, after closing Tuesday at 102.25.

Turkey does still have €3 billion to €3.5 billion to raise this year, a buyside source said.

Turkey already issued €1.25 billion this February under its eurobond program.

Meanwhile the government of Kazakhstan expressed concern that Kazakh banks have been overly reluctant to loan money or to offer loans at reasonable rates, a market source said.

The fast-growing construction sector may suffer from a stifled housing market. Housing makes up approximately an 8% share of the country's GDP, the source said.

After many years of growth, the source expects a slowdown in GDP growth this year.

LatAm up on modest rally

Latin America is widely considered a sector with good long-term investment value. Yet even after the Fed cut which spurred on emerging markets, many of the region's benchmark sovereigns made little progress, or none at all.

In Brazil, as inflation concerns linger, retail sales have stumbled to below predicted levels, according to a market source.

The source expected retail sales to hit 10.0% growth year-over-year in July, but the number fell short at 9.2%.

Brazil's frequently-traded 11% notes due 2040 held flat at 133.90, unchanged from Tuesday.

Mexico's assets performed well thanks to the easing of U.S. interest rates as the two economies are closely linked.

A market source was glad to see chairman Bernanke act in the interest of limiting spillover from the credit crunch.

Although Argentina has seen the benefits of the recent market lift, the risk of inflation still remains a problem.

President Nestor Kirchner recently blamed the Argentine business community for "greedy pricing practices" which have caused the rise in inflation, a market source said.

Many market watchers consider the government's monetary policies and undervalued currency accomplices, if not the root of the inflation problem.

The Argentine peso ended the day 3.129 to the dollar.

Argentina's high-beta 8.28% sovereign ended the day slightly up 91.50 after closing at 91.20 on Tuesday.

Also in Venezuela, government-controlled PDVSA and Russia's private oil-giant Lukoil may have struck a deal to jointly construct a heavy oil refinery in southern Venezuela, a market source said.

Whether the deal comes to fruition may not be known until early next year.

Even if the deal goes into effect, it will not likely have any immediate results, but if the plans are executed efficiently production capacity in the long term will improve, the source added.

Venezuela's 9.25% notes due 2027 gained 2.25 in trading Wednesday to end at 102.25.

Primary on the verge

In the primary market, no issuers were sufficiently emboldened by the Fed rate reduction to price any deals, but optimism is easier to find than in weeks past when one market source declared the primary dead, and closed for business until next year.

"I think there is a good possibility," a strategist said about the chance for the pipeline to pump through a modest number of deals in the near future.

"There's issuers on the sidelines," the strategist said, adding: "I think conditions are right."

Under the current primary atmosphere it would cost less for companies and countries to raise money.

"The yield issuers would have to pay would come down somewhat," the strategist said, adding that spreads are down as well.

Although emerging markets has been almost incapable of pricing issues lately, "it's kept going throughout this whole thing," a syndicate desk official said.

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