LONDON: Emerging debt spreads narrowed to their tightest in seven months and stocks rose 1 percent on Tuesday as European Central Bank liquidity continued to draw investors into emerging markets, while investors in Hungary eyed a likely freezing of EU aid. Emerging sovereign debt spreads narrowed by 3 basis points to 314 bps, their lowest level since August 2011. MSCI's benchmark emerging stock index climbed almost 1 percent with gains led by Russia, India and China in early trading, buoyed further by data showing German analyst and investor sentiment rose significantly more than expected to its highest level since June 2010. Analysts say the effects of the European Central Bank's long-term refinancing operation (LTRO) are still filtering their way through the system and helping emerging markets. "The underlying story that has been supporting the markets is the liquidity from the LTRO, a very important proportion of the market is still buying into that theme," said Imran Ahmad, emerging markets strategist at RBS. "CEEMEA was most at risk in Q4. It's seeing a little bit of a catch-up." Emerging equities were supported by the widely-watched ZEW investor sentiment survey from Germany, which smashed forecasts, with some economists saying Europe could soon catch up the region's strongest Economy. Investors were awaiting the outcome of the Federal Reserve meeting, with lowered expectations of further quantitative easing likely to put a brake on emerging market gains. Hungary aid The European Union prepared to freeze half a billion euros in aid to Hungary on Tuesday, for the first time punishing a member state for flouting budget rules, but Hungarian assets largely shrugged off the news. Hungarian stocks rose 0.9 percent to their highest levels in more than a week and the forint was steady after a higher-than-expected rise in the country's headline annual inflation rate to 5.9 percent. Hungarian five-year credit default swaps (CDS) dropped by four basis points to 521 bps, according to Markit. Ratings agency Moody's said a delay in securing IMF/EU funds and the suspension of EU cohesion funds for 2013 would "exert pressure on Hungary's ratings." Yet investors are now mainly pricing in such a deal. "We expect the financial aid package from the IMF/EU to be agreed this quarter," said BNP Paribas analysts in a client note. "The main benefit of the facility will be its confidence-boosting effect." Ukraine Ukrainian five-year CDS fell by 18 basis points to 760 bps, after rising initially after Prime Minister Mykola Azarov said late on Monday he wanted the International Monetary Fund to unlock funds from the present frozen bailout program so it can repay debt due this year. Analysts remained unconvinced the IMF would release cash to help the country refinance about $3.1 billion of debt from the previous bailout program. "I cannot imagine the IMF will let them refinance. There is a program, there are terms of repayment," said Tim Ash, head of CEEMEA research at RBS. Russian CDS dropped by five basis points after the country's central bank left key interest rates unchanged and said the current spread between lending and deposit rates was appropriate for coming months. –Additional reporting by Carolyn Cohn
