Emerging debt investors face test as returns negative

Emerging market investors will have their mettle tested in the coming week as they face the prospects of both weak retail sales adding to recession fears and uncertainty over Venezuelan oil assets.

Overall emerging debt returns fell into negative territory last week, brought lower by weak U.S. equities and building evidence that America's economy is heading for contraction.

The benchmark JP Morgan Emerging Markets Bond Index Plus saw total returns fall 0.52 percent for the year after rising as much as 0.82 percent by mid-January.

"Next week we continue to test lower. I think that there are people out there now who are going to start worrying about actual performance since we've gone into negative territory," said Enrique Alvarez, Latin America strategist at IDEAglobal in New York.

Emerging market sovereign bonds, which are typically referred to as high-yield, high-risk investments, are still outperforming high-yield U.S. corporate bonds, according to Merrill Lynch data. Merrill's index is down 1.84 percent year-to-date.

Alvarez believes the performance of Brazil's prices in the coming week will hold the key to how the overall market performs given its standing as the most liquid market.

Brazil's long-dated bonds due 2034 and 2037, especially, have seen prices grind lower, testing support levels.

"I think it doesn't have anything to do with the fundamentals at this point in time but is related to the technical's of bond performance," he said.

The slowing U.S. economy and the mess in the credit markets are proving to have a negative impact on emerging markets, putting the theory that they have decoupled to a severe test.

U.S. retail sales data for January are due on Wednesday, with a Reuters poll of economists forecasting a 0.2 percent decline.

"Price direction in the credit markets is hard to say but probably we are due for some consolidation after this sharp spread widening. I don't think there is any imminent rally in spreads coming. They will probably tighten but not back to the levels of two weeks ago," said Igor Arsenin, emerging markets debt strategist at Credit Suisse in New York.

VENEZUELA FOCUS

The freezing of $12 billion worth of assets belonging to Venezuelan state oil company PDVSA by courts in Britain, the Netherlands and the Dutch Antilles has compounded the selling pressures on the sector.

Exxon Mobil Corp (XOM.N: Quote, Profile,Research) won the court orders in a move meant to guarantee the company will be paid in the event it wins an arbitration case brought over the nationalization of its stake in a multibillion-dollar Venezuelan heavy oil project.

"The thing to look out for now is how PDVSA is going to handle this case, either settle it or have confrontation," said Arsenin.

Venezuelan sovereign bonds plunged on the news last week because PDVSA is the government's main source of revenue.

Financing in the region could be severely impacted if Venezuela is forced to pay off Exxon Mobil. This would reduce the amount of financing it is providing to regional neighbors Argentina, Bolivia and Ecuador.

"These countries are kind of joined at the hip ... I think this is going to be a drawn-out process as far as facing Exxon in courts and make these freezes go away. On the other hand you always have the open possibility that the rhetoric from President (Hugo) Chavez inflames the situation. People are going to be very wary of that going forward," said IDEAglobal's Alvarez.

One positive note from the affair came from Fitch Ratings which said in a statement on Friday the court decisions will have "minimum impact" on the operations or credit quality of PDVSA.