Emerging debt-Yield spreads narrow on positive market outlook

By Daniel Bases

NEW YORK, May 2 (Reuters) - Emerging market sovereign bond spreads narrowed sharply on Friday, though the improvement was based more on a big drop in underlying U.S. Treasuries rather than robust buying of the sector.

Dollar-denominated sovereign bonds had their prices trimmed, but sentiment in the sector was positive following better-than-expected U.S. jobs data and a growing sense the worst of the U.S. credit crunch is past.

The U.S. economy lost jobs for a fourth straight month in April -- 20,000 -- but at a slower pace than earlier in the year, easing some fears that the economy was heading into a deep recession. For details, see [ID:nN02551119].

A U.S. recession is feared, especially in emerging markets, as the United States serves as a destination for their high-priced commodities and value-added goods and services.

"The market took the payroll numbers positively," said Igor Arsenin, emerging markets debt strategist at Credit Suisse in New York.

"There is a rally in credit markets. It is affecting the EMEA time zone more than Latin America, probably because people started out being shorter on credits there than in Latam," he said, referring to Europe, the Middle East and Africa.

Investors who hold short positions have borrowed securities and sold them in the hope they can buy them back at a lower price, return what they have borrowed and pocket the profit.

If the bet, which is based on a negative outlook, does not work and prices keep rising, the short-seller is forced to buy back the assets, thereby feeding into a rally.

Arsenin said the rally reflects the increase in risk appetite for investors, and the result is a selling of risk-free U.S. Treasuries for assets with potentially higher returns.

Five-year credit default swap spreads for Kazakhstan KAZAKH5UA= narrowed by 15 basis to 230 basis points. Russia's five-year CDS RUSSIA5UA= spread narrowed by 10 basis points to 91 while Turkey's narrowed by 9 basis points to 231 basis points TURKEY5UA=. Credit default swaps (CDS) offer investors protection against defaults or credit restructurings.

For most emerging market countries, Friday's trade was the first chance to react to Standard & Poor's upgrade of Brazil's credit rating to investment grade. It was the first ratings agency to do so, making the announcement late on Wednesday ahead of the May 1 holidays.

Brazil's benchmark 2040 bond BRAGLB40=RR slipped 0.25 point in price on Friday after rallying strongly this week to bid 136.875, yielding 4.910 percent. Brazil's five-year CDS BRAZIL5UA= spreads narrowed 4 basis points to 96.

On Friday, the benchmark JP Morgan Emerging Markets Bond Index Plus 11EMJ .JPMEMBIPLUS yield spread narrowed by 13 basis points to 248 basis points over U.S. Treasuries. The index is up 1.14 percent this week on a total return basis.

"I think the Brazil upgrade does give some positive momentum to the market and even to other countries in Latin America. I think, however, for the time being we may just trade rangebound," said Cristina Panait, emerging market debt strategist at Los Angeles-based fund manager Payden & Rygel.

Panait said activity in the debt markets was relatively quiet as trading desks remain thinly staffed from the holiday.

Illustrating the better tone to investor sentiment was the rise in emerging market stocks. The Morgan Stanley Capital International's emerging market stock index .MSCIEF rose 1.17 percent on Friday to a fresh 3-1/2-month high.

ARGENTINA UNDERPERFORMANCE

Amid the renewed risk appetite, investors were bearish on Argentina, which for many has been weighed down by a morass of economic policies that do not address a persistent inflation problem nor the damage from a running dispute between the government and farmers.

On Friday, Argentine farmers said they would limit sales of agricultural goods in a renewed protest against a tax hike on soy exports while continuing their negotiations.

"Frankly I am concerned, not necessarily about the crisis in the short term, but I think economic policies there are not sustainable in the long term," said Payden & Rygel's Panait.

"They are running an economic growth policy and trying to keep the currency weak. It is difficult to manage an economy the way the (Cristina Fernandez de) Kirchner administration has been. Trying to control inflation with price agreements and export taxes instead of sound monetary policy is not a good thing," Panait said.

Argentina's portion of the EMBI+ index narrowed by 8 basis points to 539 basis points, but total returns were down 1.60 percent, by far the worst performance of the day. (Editing by Jonathan Oatis)