Emerging market debt soft ahead of long weekend; $23.6 million in outflows; OCBC sells $500 million

By Reshmi Basu and Paul A. Harris

New York, June 10 - With little news to move emerging markets debt, spreads widened slightly in a light trading day as investors headed into the long weekend.

In primary news, Singapore's third largest bank Oversea-Chinese Banking Corp. Ltd. priced $500 million of floating-rate notes (Aa3/A/A+) at Libor plus 10 basis points.

Meanwhile emerging market bond fund outflows totaled $23.6 million for the week ending June 9, according to EmergingPortfolio.com Fund Research, a firm which tracks dedicated emerging market funds.

This represented 0.15% of assets under management for the week ending June 9 compared to an outflow of 0.66% for the week ending June 2.

Global funds had inflows of $58.4 million for the week ending June 9.

"It's a reflection of more of the same that emerging market bonds are not the most attractive asset class right now," said Brad Durham, managing director of EmergingPortfolio.com.

"The latest murmurings from Greenspan that the Fed would react a little more aggressively if inflation were to spike are certainly not helpful, which has resulted in some outflows.

"But the general tone has been a little better in the last few weeks. At some point the emphasis is going to turn back towards fundamentals. And these individual markets are still strong," Durham noted.

Prices down Thursday

Despite the recent stronger tone noted by Durham, on Thursday emerging market debt was down across the board with no real outliers. The JP Morgan EMBI Index fell 0.36% during the session. Its spread to Treasuries widened five basis points to 492 basis points.

"Tomorrow [Friday] the market is closed and today [Thursday] there was not a lot of liquidity," said a trader.

During the session, there was no real news to drive the market.

"Everyone is out. No one is trying to move the market so we just sit," added a buy-side source.

Treasuries don't help

Emerging market debt also slid Wednesday as U.S. Treasury prices fell on increased uneasiness about how aggressively the Federal Reserve will act in June.

But on Thursday, emerging markets failed to rally with Treasuries after initial jobless claims increased to 352,000 from 344,000 the previous week. Then, when Treasuries gave up most of their gains to end unchanged to slightly higher, emerging markets debt fell with them.

"It's really more dependent on flows. There was one account that liquidated some positions in Venezuela and Brazil and those countries sold off more than everything else, purely on technicals," said the trader.

"And when the Treasury market sold off the market sort of repriced with it. But there was not a lot of activity in terms of trading."

Brazil's debt was mostly lower Thursday. The Brazil C bond was down one point at 89 bid in late trading. The bond due 2030 was unchanged at 97¾ bid in late trading.

Venezuela's bond due 2027 was down 1¼ points at 84 bid. The bond due 2034 was also down 1¼ point, at 83½ bid.

Peru was unchanged on the day while the rest of the market was down, outperforming the overall measure but not up.

"Peru has done better in the past few days on the news of the S&P upgrade to BB from BB-," said a second buy-side source.

"The long-duration paper, the Peru bond due 2033, is up 1.25, while most of the emerging markets are down."

Meanwhile Brazilian corporates were "off a little bit" during Thursday's session, according to an emerging market analyst.

"There's not a lot of movement going on today. The whole market appears to be moving in one piece," said the analyst.

Interest rate scare

One cause for concern at the moment is the memory of what happened a decade ago in the last rate increase cycle. In 1994 rapid interest rate hikes spooked the Treasury market and brought on the Mexican peso crisis, according to the second buy-side source.

"Some emerging markets will be hurt more than others in an aggressive rate hike cycle. Asian debt moves with Treasuries but the others have widened to Treasuries.

"The Latins could make sense. They're big borrowers.

"But right now people are unsure and so they are selling everything," noted the second buy-side source.

Argentina woes

The International Monetary Fund is sending a mission to see whether it should continue to lend to Argentina. Last week, the government offered to pay past-due interest in its second proposal to bondholders over its 2001 default. The haircut on the existing debt would be 75%.

This week, bondholders failed to show up at a scheduled meeting.

"You have to take a few steps backwards to see what led Argentina into their current situation," said Jephraim P. Gundzik, president of Condor Advisers, which provides emerging markets investment risk analysis.

The government was overextended and carried too much foreign debt that could not be supported by the economy under the confines of tight fiscal policy, said Gundzik

"Essentially, the IMF made this disaster and forced them into default," he added.

Investors will now have to come to terms that they are not going to get anything more than 25 cents on the dollar.

"That's the way it is. If they were to get more than 25 cents on the dollar, then Argentina would be back in the same situation in five years' time - face another negotiation or go through another default and have another economic disaster," Gundzik told Prospect News.

Argentina is now taking steps to move away from how things were negotiated in the past.

"And saying we are not putting the interests of the investors first this time around.

"We are putting the interests of our population first, which is pretty revolutionary for an indebted country to take, especially for Latin America."

And according to Gundzik, the government's deal will not improve substantially. Eventually, he added, the dispute will be tied up in the courts.

"The position of the Argentines is that we can't afford to pay anymore, which is true. If they pay more their economy will be back in the low growth track. They will face high unemployment and social debt.

"What do they have to lose if they go into protracted litigation? Nothing. They will be isolated from international capital markets. But that's probably better for them because that will prevent them from getting back into heavy debt."

"They are not beholden to investors or the U.S. government. They will do what they want to do."

What is much more important are the implications on the broader scale for emerging markets, such as Brazil and Turkey. Brazil is in the same situation as Argentina, according to Gundzik. It still has not sunk in for investors that its policies are the same as those that forced Argentina into default.

"The IMF is in a difficult position. If the IMF cuts Argentina off, the IMF probably has more to lose than Argentina," notes Gundzik.

Argentine bonds saw little movement on the session Thursday. The bond due 2006 was down 1½ points at 29¼ bid. The bond due 2012 was unchanged at 30½ bid. And the bond due 2030 was unchanged at 27 bid.

Oversea-Chinese Banking prices

Oversea-Chinese Banking priced its three-year floating rate notes via Citigroup, Deutsche Bank Securities

The tight pricing, in an environment of rising interest rates, is a strong endorsement of OCBC Bank's credit standing, the company said in a news release.

"We are pleased with the enthusiastic response from investors in the take-up of these FRNs, our first senior debt issuance in the offshore capital markets," said David Conner, chief executive officer, in the release.

"The success of OCBC Bank's inaugural senior debt issue will raise the bank's profile in international capital markets and ultimately enable us to develop a more diverse investor base around the world," he added.

Also pricing during Thursday's session was a $250 million bond offering from Korea's National Agricultural Cooperative Federation. It came via Credit Suisse First Boston, ABN AMRO and HSBC. No further details were available at press time.

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