Emerging Debt-War fears hover, holding prices steady

www.forbes.com Reuters, 01.28.03, 12:47 PM ET By Pedro Nicolaci da Costa

NEW YORK, Jan 28 (Reuters) - Emerging market debt traded mostly flat on Tuesday as investors awaited concrete news about a possible war in Iraq and scanned global financial markets for a sense of direction.

After United Nations inspectors on Monday delivered a scolding but inconclusive report on their hunt for weapons of mass destruction within Iraq's borders, emerging markets were holding tight ahead of U.S. President George W. Bush's State of the Union address on Tuesday night.

J.P. Morgan's benchmark Emerging Markets Bond Index-Plus narrowed a meager 9 basis points to 742 over comparable safe-haven U.S. Treasuries. The spreads over comparable U.S. Treasuries are the premium investors demand to compensate for risk.

Fears that a conflict would dampen investors' appetite for risk and drive them out of emerging markets continues to stand as the backdrop for emerging debt trading, a scenario unlikely to change until there is a clear resolution to the standoff in Iraq.

"The external factors to emerging markets are what's on investors' minds at the moment," said Paul Masco, head of emerging market trading at Salomon Smith Barney.

Sinking U.S. stock markets, which have been flirting with three-month lows, pressure on a wobbly U.S. dollar and fears about Iraq have all been weighing on the market, Masco said.

In Brazil, where new President Luiz Inacio Lula da Silva is riding out his swift transition from Wall Street menace to market darling, benchmark C bonds <BRAZILC=RR> gained 0.5 points to 67.25 bid.

Investors continue to tip their hats to the policy reform efforts of the Workers Party economic team, but the geopolitical uncertainty surrounding Iraq has doused Brazil's valiant market comeback with cold water.

"The local fundamentals are quite positive, the measures taken so far are solid, the government is headed in the right direction," said Ricardo Amorim, head of Latin American debt strategy at IDEAglobal.

After posting strong gains in the first part of January, Brazil bonds are now up a paltry 0.9 percent on the year.

"The problem is that the future of Brazilian markets is going to depend as much on the internal fundamentals as on the possibility of war, and on that front, things aren't looking good," added Amorim.

Amorim said the growing likelihood of a U.S. attack on Iraq would undoubtedly dampen investors' appetite for risk and dull the allure of emerging markets. Meanwhile, in strife-torn Venezuela, where an opposition strike aimed at forcing President Hugo Chavez to resign entered its 58th day, officials were considering a fixed exchange rate as an attempt to stem rising capital flight.

The strike has crippled energy production in the world's fifth-largest oil exporter, but Chavez claims the opposition's resolve is starting to crack.

A shift in monetary policy would help preserve Venezuela's reserves and allow the country to repay its foreign debt. But analysts cautioned that fixed exchange rates had led a number of Latin American nations -- including crestfallen Argentina -- astray.

In other emerging market news, investors were awaiting a planned Peruvian bond deal of around $1 billion. The bond, which sources close to Peru's Economy Ministry said could carry a 12-year to 15-year maturity, may sell as soon as this week, analysts said.