Emerging market debt sees better liquidity; Mexico and Belize down

By Reshmi Basu and Paul A. Harris

New York, April 5 - Emerging market debt locked into gains Tuesday, while Mexico continued to underperform on ongoing political noise.

With a dearth of new economic information in the United States, debt traded in ranges as investors waited for more data to provide direction for U.S. Treasuries and inflation.

Nonetheless, emerging markets saw better liquidity, according to a Latin America debt strategist at Refco EM.

"The market rallied in the morning and then stabilized in the afternoon," he said.

Overall, debt was up. The JP Morgan EMBI+ was higher by 0.17% while its spread to Treasuries narrowed eight basis points to 387 basis points.

"You had the Brazil '40s trade around the 111. Also, the Venezuelas found some ground there," noted the strategist.

During Tuesday's session, the Brazil C-bond gained ¼ of a point to 99¼ bid while the bond due 2040 added 0.40 to 111.20 bid. The Venezuela bond due 2027 added ¼ of a point to 99¼ bid.

Mexico, Belize down

Mexico's paper continued to fall on increasing political troubles. Congress is expected to vote on Thursday on whether to strip Mexico City's leftist mayor Andres Manuel Lopez Obrador of his criminal prosecution immunity.

If found guilty, the popular mayor could be banned from running for president in 2006.

"There's a little bit of political uncertainty. That has not helped the price of their sovereigns," remarked the strategist.

During Tuesday's session, the bond due 2009 lost 0.80 to 117½ bid

Ratings action from Standard & Poor's brought down paper from Belize.

The ratings agency said that it lowered its long-term foreign currency sovereign credit rating to CCC from B-, citing the country's inability to access external financing. S&P also lowered its long-term local currency sovereign credit rating on Belize to CCC+ from B.

Belize's 9¾% global bond was sharply off at 84.0 bid, down from Monday's 86½ bid, in response to the S&P action.

New paper, wider spreads

The pipeline is building up this week as Venezuela said it would issue a minimum $1 billion 20-year bond offering via Citigroup and JP Morgan.

Also expected to tap the market, Mexico's Grupo TFM plans to sell $460 million of senior unsecured notes in two tranches.

Morgan Stanley has the books for the Rule 144A with registration rights notes.

Despite the recent widening, spreads are still at historic lows. But spreads may kick out further as issuers race to hit the market before the inevitable rate hike, according to an emerging market analyst.

"I think we'll see a mini-repeat of what happened in January through early March: spreads will stabilize, outflows will slow, and then EM issuers will rush to soak up whatever demand comes back into the primary market," he said.

"The problem, though, is that this time it will smack of desperation. Everybody knows U.S. rates are going higher, so issuers will jump on any chance to issue at current yields before they rise any further.

"That will undermine technicals again, and probably send spreads wider again. It may take a few weeks for spreads to resume their climb, but the supply/demand dynamics in the primary market will eventually push spreads higher," he commented.

GM's influence on EM

The debt strategist said that over the last 15 months emerging markets has seen an influx of non-dedicated investors.

"You see a lot of investors that usually concentrate on the U.S. high-yield market, crossing over and going to Brazil, Colombia, Mexico, and Venezuela."

The search for yield and improvements in fundamentals have generated more liquidity and more demand for paper in emerging markets, he said.

"If you see a different story in the U.S. market, and specifically in the past few weeks, the General Motors situation, you are going to start seeing some of those investors leaving the region and coming back to a more familiar ground such as the high-yield market.

"You are going to see a lot more selling in the emerging markets by non-dedicated institutions," he commented.

The strategist said that the main issue is "when and if GM's debt rating is lowered."

He added that investors would start comparing what General Motors offers against the risks of holding paper of specific countries such as Ecuador, Brazil and some of the emerging markets corporates.

"Due to the fact that you are in a more familiar ground, you will see your investors taking positions in GM and then swapping, doing some sort of asset allocation."

The other aspect regards fallen angels, he added. When investors see a credit that is losing its good standing as an investment-grade name, they tend to leave corporates and enter a safe haven - in this case Treasuries - as was seen a couple of weeks ago.

"In a similar explanation, you have investors that are constrained by their investment objectives to only invest in investment-grade paper," commented the Refco strategist.

Managers such as insurance companies and pension funds are going to drop their positions and enter Treasuries until the market settles, he noted.

"On the other side, the dedicated high-yield investor may start to look at this fallen angel as a potential play in the future."

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