Emerging market debt softer as Treasuries retreat; more local currency deals as buyers search for yield

By Reshmi Basu and Paul A. Harris

New York, Feb. 10 - Emerging market debt slid Thursday in light trading in the wake of a pullback in U.S. Treasuries on less than stellar demand for the auction of 10-year notes.

Emerging markets were a little bit softer, said a buyside source.

"Most of it happened after the U.S. Treasury auction came in weaker than expected," the source explained.

The U.S. Treasury Department sold $14 billion in 10-year notes on the final day of its three-day auction. The notes were priced to yield 4.049%.

The auctions of three- and five- year notes this week drew more investors than expected, coming mostly from foreign central banks.

But Thursday's sale of longer maturity debt did not pique as much interest, bringing in a less-than-expected 2.05 times demand. As a result, in trading the yield on the old 10-year note moved to 4.07% from 3.98% at Wednesday's close.

Higher yields in the Treasury market took a swipe at emerging market prices.

In the late afternoon, Brazil's C bond was quoted at 102¾ bid, down 1/8 of a point.

For the day, the Brazil bond due 2040 fell 0.90 to 117.60 bid. The Mexico bond due 2008 slipped 0.05 to 121.65 bid. The Russia bond due 2030 lost a quarter of a point to 106¾ bid. The Turkey bond due 2030 was down 3/8 of a point to 145 7/8 bid.

Participation in trading was mixed, according to the buyside source.

"Fast money and maybe some real money taking over the profits," the source said. "I think it was some prices marked down by brokers. It's still very quiet."

The market has been sluggish, as trading volume has thinned out from this week's Carnival in Latin America and Lunar New Year's celebrations in Asia. The market is not expected to pick up speed until next Monday, said sources.

Overall, 2005 has been a steady year for EM, and even a better year if one was has played the long end of the curve. But the market appears to be cooling down, according to a second buyside source.

"It's been a great year except for the past 24 hours. It has been good to be long," said the source.

The source added that the primary market has been very quiet, with deals coming with little warning such as VimpelCom's offering.

On Monday, Russia's VimpelCom priced $300 million of five-year notes at par to yield 8% via JP Morgan and UBS.

"Some of the flows that had been going into the emerging markets are now going into the high-yield market. So the technicals seem a little bit better.

"Emerging markets' momentum seems to have slowed down.

"I have to believe that the fundamental demand is still there. It will keep going until it can't go anymore," remarked the second buyside source.

Looking ahead, the first buyside source is slightly concerned over the noise in Venezuela and Colombia.

"In the medium term, I see the deterioration of the Venezuela/U.S. relationship - that could be a very negative development," said the source.

The Bush administration has voiced concern over Venezuela's planned arm purchase from Russia. And Venezuela is making moves to sell its oil to countries other than the United States.

Meanwhile Colombia has seen clashes between the military and rebels escalate in the last two weeks.

In trading Thursday, the Venezuela bond due 2027 fell 0.80 to 102.60 bid. The Colombia bond due 2012 slipped 0.525 to 113.60 bid.

Nonetheless, the source commented: "In the short-term, I think everything is as good as it can be."

Overall, the first buyside source is slightly overweight in emerging markets.

"We've held through the weakness at the beginning of the year. It's hard to give up the carry, and no one wants to be the first one to sell. We have not made any major changes to that."

Local currency deals and the search for yield

Brazil's Banco ABN Amro Real SA, acting through its Grand Cayman branch, plans to issue at least R$100 million of inflation-linked notes due February 2010.

The issue will be purchased in local currency and payable in dollars.

ABN Amro Bank NV is the lead manager for the Regulation S deal, which is expected to price this month.

Some have commented that the dollar is oversold and local currency deals are not worth the risk, given that local currencies could tailspin. But the search for yield above 8% finds little else these days.

Local currency deals "are the only places you can get any yield in EM these days, but many EM currencies are overvalued and present serious depreciation risk," said an emerging analyst.

"Yes, yields in Brazil are high, but the 6-month USD/BRL forward contract is only around BRL2.80, and everyone knows we could easily shoot through that in six month's time on a market correction.

"Other currencies, like the Colombian peso, might not be so overvalued, but they offer much lower yields. So there's no really compelling local markets trade out there right now, other than very short-term trades in Brazil or other high-yielding local markets," noted the analyst.

Sberbank weak in secondary

Russia's Sberbank priced a $150 million add-on to its 6.23% eurobonds due Feb. 11, 2015 (Baa2) at par on Monday via UBS Investment Bank. Sberbank priced the original $850 million issue on Feb. 4, 2005 at par.

"The deal went well but the bonds weakened in the aftermarket," said the second buyside source.

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