Emerging markets cheer U.S. rescue plan, but investors remain cautious

U.S. officials announced Friday they are working on a solution to take over hundreds of billions of dollars worth of bad mortgage debt. The government also curbed short-selling in the stock market and said it will use $50 billion to back money market mutual funds.�

The news from Washington boosted markets on the hopes that the credit crunch and the financial crisis would come to an end before it gets wider and deeper.

Despite the positive reaction, analysts were cautious about the economic outlook for emerging markets in the medium term given an expected slowdown in global growth.

Yield spreads between emerging market bonds and U.S. Treasuries, an important gauge of investors' aversion to risk, narrowed by 66 basis points to 353, and total returns rose 1.81 percent, according to the benchmark JP Morgan Emerging Markets Bond Index Plus.

“These measures are helping calm things down a bit, bringing a little order to the chaos,” said Jorge Dib, portfolio manager at Sao Paulo-based BRZ Investimentos. “The market was working in the dark for the past few days, not being able to see the full extent off the crisis,” he told Bloomberg News.

The MSCI emerging market stock index surged 10.23 percent, bouncing from Thursday's two-year low. Turkey, Russia, China and Brazil led the rally as every emerging stock market. The benchmark 100-index of Istanbul Stock Exchange’s rose 12.8 percent.

Russia's Micex Index rose the most ever as President Dmitry Medvedev pledged $20 billion to end the nation's worst financial crisis since the 1998 default. China's CSI 300 Index rose a record 9.3 percent. In Brazil Bovespa index rose 9.28 percent.

"The situation clearly improved compared to yesterday morning. At the same time I would say a number of risks remain. It is clear that global growth is likely to slow down more than what was thought a week ago, before the Lehman default and all these bail-outs," Igor Arsenin, emerging markets debt strategist at Credit Suisse in New York, told Reuters

"Volatility is likely to continue into next week because the resolution of this crisis is likely to be kind of slow," he added.

CURRENCIES JUMP

Latin American currencies climbed, led by a 6.7 percent jump in the Colombian peso, its biggest gain in at least 13 years.

The measures came at the close of a week that saw the bankruptcy of Lehman Brothers Holdings, the hurry-up wedding between Merrill Lynch and Bank of America, and the government bail-out of insurance giant AIG.

Worries over a collapse of the financial system had scared investors away from risky emerging market assets. On Wednesday, the JPMorgan EMBI+ index reached 428 basis points, the widest since October 2004, and stock markets throughout Latin America plunged.

In Brazil, Latin America’s leading economy, the real currency, posted its biggest gain since August 2002, rallying 5 percent after the central bank sold $500 million in dollar repurchase agreements to supply the market with liquidity. The real closed up 4.74 percent at 1.83 per dollar.

Latin American bonds also rallied. The yield on Mexico's 10 percent bond due in December 2024 dropped 33 basis points, or 0.33 percentage point, to 8.54 percent.

The bonds' price rose 3.07 centavos to 112.74 centavos per peso, according to Banco Santander. The yield on Argentina's 5.83 percent peso bonds due in 2033 dropped 79 basis points to 10.59 percent, according to Citigroup Inc.'s local unit.