Emerging debt to watch yen, U.S. mortgage market

By Walter Brandimarte

NEW YORK (Reuters) - The strength of the yen and possible turbulence in the U.S. mortgage market will likely be the main concerns of emerging debt investors this week, as high-yielding bonds try to consolidate their recent recovery.

The Japanese currency is right now the main source of uncertainty: should it keep erasing recent gains, short-term investors who take advantage of the carry trade may feel comfortable to fully return to the market, analysts say.

If the yen starts strengthening again, however, it could become too expensive for investors to keep borrowing on the safe currency in order to invest in high-yielding assets.

"As the yen depreciates or stabilizes at these levels against the dollar, I think we can see a little more confidence coming back into riskier categories, which is what you've been seeing in the last couple of days," said Enrique Alvarez, Latin America debt strategist for IDEAglobal in New York.

Last week the yen lost more than half of the gains against the dollar it had accumulated during the days of global turbulence seen in the end of February and beginning of March.

The partial return of the yen carry trade allowed emerging sovereign bonds to rise 0.4 percent last week, according to JP Morgan's EMBI+ index 11EMJ .JPMEMBIPLUS, enough to erase all the losses incurred during the global sell-off.

Yield spreads between emerging bonds and U.S. Treasury notes, an important gauge of risk aversion, ended Friday at 179 basis points, 12 basis points tighter for the week.

Finally reflecting the recent spike in risk aversion, however, dedicated emerging markets bond funds saw outflows of $555.2 million in the week ending March 7, after more 20 consecutive weeks of inflows, according to data from Emerging Portfolio Fund Research.

Turbulence stemming from the U.S. subprime mortgage market could also curb the performance of emerging bonds this week.

"I think the U.S. mortgage markets, in particular the subprime mortgage market, will be a major source of noise into the U.S. environment and I think that should trickle through into Latin America," IDEAglobal's Alvarez said.

Emerging markets investors should also pay some attention to U.S. economic data, like retail sales on Tuesday and consumer inflation on Friday, to make sure the world's largest economy remains slowing down in a paced way, without spikes in inflation.