Brazil 2019 Bond Yield Gap Narrows as Europe Rebounds

Waning concern about debt defaults in Europe is starting to be reflected in the relative prices of Brazil’s government bonds.

The gap between yields on Brazilian 8.875 percent notes due 2019 that were sold in 2004 and its 5.875 percent securities issued in 2009 and that mature that same year narrowed to 21 basis points, or 0.21 percentage point, from 28 at the start of this month. The so-called spread, which reached the widest point since November, averaged 13 this year, according to data compiled by Bloomberg.

Credit-rating downgrades in Greece, Spain and Italy eroded demand for Brazil’s less-traded 8.875 percent notes as investors sought securities they could sell more easily. Now that a 750 billion euro ($930 billion) bailout package for the region is shoring up confidence in the global economic recovery, the gap between the two bonds will shrink to about 10 basis points as financial markets rebound, according to Barclays Plc.

“Brazil is going to benefit from increased flows with the re-assessment of risk aversion,” said Kathryn Rooney Vera, a strategist at Bulltick Securities Corp., a Miami-based brokerage with offices in four Latin American countries.

Investors wanted “to be in the most liquid names so they can exit them quickly because this is a time of volatility,” Rooney said in a phone interview. “Since they’re the same maturity, the difference is only by a few months, there shouldn’t be much of a spread differential between the two.”

Trading Disparity

The yield on the $1.3 billion of 8.875 percent notes has dropped one basis point since mid-April to 4.78 percent as its price fell 0.37 cent on the dollar to 130.48 cents, according to data compiled by Bloomberg. The yield on the $2.3 billion of 5.875 percent notes dropped nine basis points to a six-month low of 4.55 percent as its price climbed 0.51 cent to 109.30 cents.

Trading in the newer securities totaled $1.98 billion in the first quarter, more than 10 times the $187 million traded of the older issue, according to the Emerging Markets Trading Association in New York.

“Liquidity tends to be around bonds that are newly issued with the price of the bonds close to par,” said Donato Guarino, an analyst at Barclays in New York. “In moments when risk aversion is higher, investors feel more comfortable owning liquid bonds.”

Buyback Program

European Union officials last month agreed on an unprecedented 750 billion-euro rescue package for distressed nations after a separate 110 billion-euro lifeline for Greece failed to contain the debt crisis and shore up the euro. The region’s finance ministers last week agreed on the structure of a 440 billion-euro European Financial Stability Facility, the main part of the bailout plan.

The European Union and International Monetary Fund agreed last month to provide 110 billion euros of aid to Greece as the country struggled to control a deficit that reached 13.6 percent of gross domestic product last year. They also set up a financial lifeline to backstop the region and defend the currency prompting the riskiest nations to agree to ‘austerity measures that include painful deficit cuts.

Brazil may buy back the 8.875 percent bonds in a program that retires less-traded securities, Deputy Treasury Secretary Paulo Valle said in a telephone interview from Brasilia yesterday. The government had reduced the amount outstanding by $152 million as of March, according to the Treasury.

The 5.875 percent notes aren’t a repurchase target because “they have enough volume and liquidity,” Valle said.

‘Brief Distortion’

The yield premium on Brazilian dollar government bonds over U.S. Treasuries has narrowed 24 basis points to 227 since touching a nine-month high of 251 on June 8, according to JPMorgan Chase & Co.’s EMBI+ index. The yield spread rose three basis points at 9:56 a.m. in New York.

The cost of protecting the nation’s debt against non- payment for five years with credit-default swaps rose one basis point yesterday to 134, according to data compiled by CMA DataVision. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

The real strengthened 0.5 percent to 1.7790 per dollar. It’s appreciated 2.4 percent this month, following a 4.5 percent slide in May. The yield on Brazil’s interest-rate futures contract due in January, the most active in Sao Paulo trading, rose six basis points to 11.26 percent. That rate shows traders expect policy makers will boost the rate to about 12 percent by year-end, according to data compiled by Bloomberg.

The 2019 bonds are Brazil’s only two dollar securities maturing the same year and offering different rates, according to Barclays.

“This is a brief distortion that occurred,” Enrique Alvarez, head of Latin America fixed-income research at IDEAglobal, said in a phone interview from New York. “If we see some sort of reversal, the spread should change. At some point, it will narrow.”