Emerging markets hold rally pace; Venezuela, high-betas soar; EMBI+ reels back in

By Aaron Hochman-Zimmerman

New York, Sept. 19 - Emerging markets continued to win back what it had lost earlier in the week.

The high-beta credits in Latin America led the way higher, following a solid performance by emerging Europe.

Venezuela stood out above the crowd as it added 9 points to its benchmark bonds due 2027.

Slow and steady Asia was not as reactive, but managed to regain almost all of the losses from the maddening week.

Still, the recovery did not have the feeling of permanence.

"You're going to need to see the hedging instruments hold here for a period of time before you see an increased risk appetite," a trader said.

"That will spread from sovereign cash to investment grade, then to the higher-beta stuff," he said, calling the past two sessions "a first step."

Over the days of volatility, credit risks on the emerging market sovereign side have not changed very much, a strategist said.

Issuers such as Brazil and Russia still have enough in reserve to buy back all of their debt, he said.

On Friday, volatility remained lower throughout the session ending off by 1.03 at 32.07, according to the VIX index. The index is a commonly used yardstick of market volatility.

The turnaround for Treasuries drastically wound in spreads in emerging markets as JPMorgan's EMBI+ index tightened by 64 basis points to a spread of 355 bps. The index determines the amount of extra yield investors will demand to keep assets in emerging markets debt.

Discounting Treasury action, tightening is only about 23 bps to 24 bps, a strategist said.

Also, the EMBI global diversified index, which represents sovereigns and quasi-sovereigns was tighter by 58 bps with a spread of 387 bps.

The diversified index has a less strict liquidity rule for inclusion.

LatAm selling was 'overdone'

In Latin America, the sell-off proved to be "overdone," especially on the sovereign side, a strategist said.

Over the week, local markets marched to the beat of their own drum as they asserted themselves with buying in local currencies, he said.

Meanwhile in Venezuela on Friday, two workers with Human Rights Watch were expelled from the country.

The recent release of a report criticizing Venezuela's human rights record was followed by the expulsion of Jose Miguel Vivanco, Americas director for Human Rights Watch.

The foreign ministry claimed Vivanco "illegally interfered in the country's internal affairs."

The incident follows the cessation of diplomatic relations between the United States and Venezuela and Bolivia.

Still, investors were undeterred as the 9¼% Venezuelan government bonds due 2027 added 9 points to 84.5 bid, 85.5 offered.

In Argentina, the Paris Club is demanding a more comprehensive plan from the government detailing how it will pay its outstanding debts, the Buenos Aires Herald reported, citing an unnamed source.

The 8.28% Argentine discount bonds due 2033 tacked on 6 points to 65 bid, 65.5 offered.

In Brazil, the 11% bonds due 2040 were improved by 1.5 points to 128.5 bid, 129.5 offered.

Investment grade Mexico, which had outperformed in the decline as investors ran to Treasuries, traded higher in the recovery as well.

The 5 5/8% Mexican government bonds due 2017 added 1.5 points to 99.5 bid.

In corporates, "It's been amazing," another strategist said. "There's no cash trading."

"I think it's going to be a little while ... we're just trying to understand this thing," the strategist said.

Asia stays strong

Asia continued to outperform the emerging market sectors on a weekly basis on Friday.

"It's really performed very strongly today," a trader said.

"The tone was at the worst about a half-hour before Paulson's announcement" on Thursday, he said.

Investors had "Armageddon hedges" on while the announcement caught people by surprise, he said.

The massive hedges led to the short squeeze on Friday, he said.

Throughout the extreme volatility of the week, "we clawed back a good part of the sell off," he said.

"If you look at it spreadwise, we really haven't moved that much in a week on week basis," he said.

In the Philippines, the banking system is "sound and stable," according to a press release from the central bank.

It "has a solid capital base and has limited exposure to Lehman Brothers in the U.S. that has declared bankruptcy," the release said.

"The reforms we have instituted in the past years are serving us in good stead in terms of capital buildup, enhanced risk management, and adherence to good governance. We are confident therefore that our banking system can withstand the fallout from the financial crisis in the United States," the release continued.

The peso was seen trading at 46.45 to the dollar.

The Philippine government bonds due 2030 were spotted at 127 bid, 128 offered.

In Indonesia, locally produced goods need protection from new bilateral and regional free trade agreements, Indonesian Chambers of Commerce and Industry vice president of trade and distribution, Ketut Suardhana Linggih, told the Jakarta Post.

"Free trade has been unfair to Indonesia because it has no strategies to protect its local products," he said.

"The U.S. supports free trade very much. Meanwhile, it also has a strong commitment to protecting its local industries," he said.

The lack of protections has allowed foreign products to drop prices below domestically produced goods.

"Nowadays, 70% of the products sold [in central Jakarta] are made in China, with good quality and lower prices," he said.

The Indonesian bonds due 2017 were seen at 98 bid, 100 offered.

Also in Pakistan, the government bonds due 2017 were quoted at 53 bid, 56 offered.

In corporates, South Korea's MagnaChip Semiconductor could not match the success of the sovereigns.

The 8% notes due 2014 gave up 4.25 points to 16.75 bid, while the 6 7/8% notes due 2011 were unchanged at 37 bid, 39 offered.

Emerging Europe climbs higher

Emerging Europe posted another rally day over heavy flows on Friday.

Encouraging news from the United States helped propel investors to take on more risk, but the consensus was that the success may be short-lived.

In Russia, both president Dmitry Medvedev and prime minister Vladmir Putin addressed the global economic crisis.

"After the depression in the United States all economies built on market principles developed problems," Medvedev at the Kremlin, according to the Itar-Tass News Agency.

"That's what the key world players should be focused on," he said.

While in the resort city of Sochi, Putin discussed the benefits of collective economic security.

"Through mutual investments we are becoming more dependent on one another. This is a safeguard against all sorts of unpredictable developments," he said, according to the RIA Novosti News Agency.

Still, Russia will continue to build a self-sufficient commodity exchange and improve the investment tax system.

Putin's vision of a more liberalized economic environment includes higher productivity, cost cutting and the improving the country's education and public health infrastructure.

The Russian government bonds due 2030 jumped 3.5 points to 105 bid, 106 offered.

In Turkey, financial leaders weighed in over the recent shocks of volatility which have coursed through the world's markets.

Chairman of Zorlu Holding, Ahmet Nazif Zorlu said that the current crisis is still less severe than what Turkey experienced in 2001.

Still, "our companies should orient toward savings, and try to increase productivity. We may experience problems in external borrowing, in the medium-term," he said, according to the Turkish Daily News.

The chairman of Anadolu Holding, Tuncay Ozilhan was less optimistic, calling the downturn the worst in 50 years.

"It is a misfortune that local elections overlap with the global crisis. We will have to abstain from political fluctuations during the process," he said.

"The rise of inflation is likely to continue, just like the rest of the world... However, it will be an advantage for us that raw material prices will decline," he added.

The lira was seen trading at 1.8113 to the dollar.

The Turkish sovereigns due 2030 improved by 4 points to 147 bid, 147.5 offered.

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