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Emerging debt-Tepid recovery in prices with rates, issuance eyed

January 11, 2005 | Reuters

Emerging debt on Tuesday showed tepid signs of recovery after losses due to a warning from a U.S. Federal Reserve official that a measured pace of interest rate rises was never a firm pledge.

On Monday, Atlanta Fed President Jack Guynn muddied the markets' view that U.S. rates were on a steady upward path that had given solace to emerging market investors making investment planning decisions.

If U.S. rates rise more or faster than factored into expectations, the risk for emerging markets is investors will shun the higher yielding and riskier sector for safer investments such as U.S. Treasuries.

Combining with the rate concerns is the seasonal factor of new debt offerings coming to the market. That could speed up if the pace of rate rises is ratcheted higher, thereby lifting borrowing costs.

"I think there is also a technical element to this weakness. It seems to me many broker/dealers went into the new year long on their books looking for strong demand from their clients. But it seems like the demand has not materialised so far," said Christian Kopf, emerging markets portfolio manager at DWS in Frankfurt.

Kopf noted the weakness in the market has been concentrated in Latin American credits, which was the top-performing emerging market sector in 2004.

"The weakness has been concentrated in LATAM because this is where most of the supply is coming from. People are concerned about supply coming from Brazil and Peru. So LATAM has weakened but eastern Europe has held quite well compared to the other regions," he said.

The benchmark JP Morgan Emerging Markets Bond Index Plus (EMBI+) showed yield spreads three basis points tighter at 373 basis points over U.S. Treasuries.

"If you have interest rates rising faster than expected, you might find countries that need to issue paper doing it earlier. The market might not want that much, that fast. (On the) other side of the coin, there is a lot of cash out there looking for yield," said one senior trader at a Russian bank in London.

Brazil rebounded from its weak close in New York on Monday. Its portion of the EMBI+, the biggest overall, showed yield spreads eight basis points tighter at 425 while its benchmark global bond due 2040 was up 0.438 points to bid 113.188, yielding 9.037 percent.

One hotly anticipated issue is expected to be Turkey. It has funding requirements of approximately $4.5 billion in 2005, of which it already pre-funded $500 million.

The first tap of the market by Turkey could be as big as $1 billion, analysts estimate.

Turkey's benchmark sovereign bond due 2030 was up 0.812 points to bid 141.125, yielding 8.035 percent.

In addition, Poland is expected to issue up to 1.5 billion euros' worth of 15-year debt by the end of business on Tuesday. Price guidance has narrowed to 27-28 basis points over mid-swaps, sources said.

Mid-swaps is the measure of interest between floating and fixed rates.

Poland's influence on emerging markets however is waning as it is part of the European Union, holds investment grade credit ratings and attracts non-emerging market investors.

Pakistan's debut dollar-denominated benchmark sized Islamic bond, or Sukuk, is expected to debut early next week. Initial price guidance was set at 220-235 basis points over six-month LIBOR (London Interbank Offered Rates). Benchmark size is loosely defined as anything more than $500 million.

Sukuks comply with sharia law which bans the receipt of interest. But the law does allow revenue sharing schemes that permit assets to produce a return. Sukuks normally trade at a fixed spread to an interest benchmark such as LIBOR.

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