* MSCI emerging stock indexes fall as flu virus spreads
* Mexican stocks drop, peso off nearly 5 pct vs US dollar
* Sovereign credit spreads widen in thin trade
By Daniel Bases
NEW YORK, April 27 (Reuters) - The spread of a flu virus and the possiblity of an epidemic knocked emerging market asset prices lower on Monday, hitting Mexico's stocks and currency hardest.
A moderate earthquake that shook southern Mexico and was felt in the capital, added further strain to an already tense market environment.
The impact of the flu virus that has killed 149 people in Mexico and spread to the United States, Canada and Europe unnerved markets globally because of its potential to slow global economic activity and prolong an already deep recession in developed markets.
MSCI's broad emerging markets stock index <.MSCIEF> fell 2.46 percent while the MSCI Latin American stock index <.MILA00000PUS> fell 4.39 percent.
Mexico's stock market had rallied over 33 percent from a five-month low on March 2 before being shunted down 3.34 percent on Monday <.MXX>.
"I think the virus is being used as an excuse for people to take some profits because I think the market is right, we will see a recovery in the U.S. sometime starting later in the year. But I think the market just got a little bit too far too fast," Gregory Lesko, equity portfolio manager at Deltec Asset Management, told Reuters Television.
The U.S. dollar rose broadly on a flight-to-safety trade
that pushed the Mexican peso down nearly 5.0 percent against
the greenback to 13.97
Other Latin American currencies were swept up in the flu
downturn. Investors pulled the Brazilian real down 1.35 percent
to 2.2210
Brazilian Finance Minister Guido Mantega, speaking to investors in New York said there was still room for further expansionary monetary policy.
Mantega said he expects the economy to continue to slow through first half of the year before beginning to recover in the second half of 2009.
Elsewhere, the Colombian peso fell 2.14 percent to 2,340
against the greenback
Emerging market sovereign credit spreads widened 15 basis points to 564 basis points over stronger U.S. Treasuries, according to the JP Morgan Emerging Markets Bond Index Plus <11EMJ><.JPMEMBIPLUS>.
MEXICO DYNAMIC
An extended rout of the peso however was not expected to last because it has $74 billion in various currency swap lines in place with the U.S. Federal Reserve and the International Monetary Fund.
"It is a shock, it is going to be there but the argument we are making is that speculators, because of the swap lines, are not going to be able to push the peso weaker," said Benito Berber, Latin American strategist at RBS in Greenwich, Connecticut.
Berber believes Mexico's central bank will likely continue an aggressive policy of monetary easing which would help the short-end of the local yield curve.
"In terms of monetary policy, inflation is going to go lower and inflation expectations are going to go lower. That is going to open a lot of room for Mexico to cut very aggressively, so 75 basis points at the next meeting," he said.
Mexico's benchmark interest rate is 6.0 percent with the next monetary policy decision expected May 15.
The economic impact of the flu virus in driving down tourism receipts and tax revenue is likely going to be felt more in external government debt.
"I think the perception is that the income and VAT are not going to be in line with the projections of the government and there is going to be a gap that the government is going to have to cover with the oil stabilization fund or going to have to cut spending. So the bonds are going to suffer," Berber said..
Mexico's long-dated Global 2040 bond
Mexico's credit default swaps, which offer protection
against defaults and restructurings, deteriorated in thin
trade. Spreads widened to roughly 35 basis points from Friday
to bid 332.6 bps, according to Markit data
"We've had very few trades today. Mexico CDS can trade anywhere between zero and 10 times a day so we've seen maybe two transactions today so not out of the ordinary," said one credit trader in New York.
"People are just on the sidelines and it is very hard to see what they are waiting for at this point," the trader said. (Additional reporting by Walter Brandimarte in New York)