latam SOVEREIGN debt
After several recent spells of political turmoil in Latin America, the risks for sovereign bonds are easing in countries with healthy checks and balances. A rally still hinges on a decline in US interest rates, but investors are finding a few bright spots.
By Hernán Goicochea
When Time magazine named Colombian President Gustavo Petro one of the 100 most influential people of 2023, his Chilean peer, Gabriel Boric, wrote that at Petro’s inauguration in August 2022 he saw the streets of Bogotá full of people and of “hope.” Less than a year later, however, that sentiment appears to have soured for some. “Do you see all the apartments and houses for sale?” said a taxi driver in the capital. “Well, that is because people are worried that Petro is going to turn the country into another Venezuela.”
This dichotomy of opinion – or the quick change in mood – is common in Latin America and the Caribbean. And this political and social turbulence can make investors in the region’s sovereign bonds selective about where they put their money.
Nafez Zouk, an emerging markets debt analyst at Aviva Investors in London, ranks Brazil, Colombia and Peru with good potential for their stable fiscal metrics because of their institutional checks and balances. This has limited the impacts of political concerns, from a storming of government buildings to an impeachment. Countries like Argentina and El Salvador still fall in the category of “bad politics, bad macro policies,” while Ecuador hangs in the balance between the two, he says.
Sovereign bond investors, he says, need to consider the intersection of macroeconomic policies and the political cycle.
In Colombia, for example, Petro caused a stir in the financial markets when he said on the campaign trail that he would raise taxes, reform the pension system and halt the drilling of new oil wells. Investors changed their minds and reacted favorably to the new president after he named José Antonio Ocampo as his finance minister on expectations that the moderate economist would bring balance to Petro’s left-leaning policies.
That worked, but only for so long. In April, Petro appointed a closer ally, Ricardo Bonilla, as his new finance minister after asking Ocampo and the rest of his cabinet to resign when a healthcare reform failed to pass in Congress.
The response has been two-fold from investors. The first view is that Petro is considered “almost like a loose cannon in the sense of proposing things as if he were still on the campaign trail,” Zouk says. “That led to a lot of investor fright because he was proposing things that are a change to the structure of the economy.”
At the same time, however, the snubbing of the healthcare reform showed that the system of checks and balances is in place to put constraints on the executive branch.
“I don’t think Colombia is out of the woods, but I think it’s in a better place than it was a few months ago,” Zouk says. “We’re not seeing deterioration in the fiscal situation – we’re seeing the current account correcting, and that is what you should be seeing when you’ve hiked rates and when you are trying to slow the domestic side of the economy.”
“I don’t think Colombia is out of the woods, but I think it’s in a better place than it was a few months ago.”
– Nafez Zouk, Aviva Investors
Colombia’s central bank has raised the monetary policy interest rate to 13.25% in April from 1.75% in October 2021 to fight high inflation, a strategy that is expected to cut consumer prices to 3% by 2025 from 10.9% in April, according to a forecast from the International Monetary Fund. That would allow the base rate to be brought down again, helping to revive growth in the economy and government revenue, a key for Colombia to keep on top of its debt payments. The economy is expected to recover to 2.9% growth in 2025 from 1% in 2023, according to the IMF.
Michael Arno, an associate portfolio manager and senior research analyst at Brandywine Global Investment Management in Philadelphia, says this change in sentiment has improved bond yields in Colombia.
At the end of June, Colombia’s 10-year government bond had a yield of 10.15%, down from 13.05% six months earlier, according to World Government Bonds. Over the same period, Mexico’s 10-year yield fell to 8.9% from 9.3%, while Brazil’s dropped to 10.95% from 12.74%, the data show.
“We saw a really interesting idiosyncratic valuation opportunity in Colombia because yields were the same relative to Brazil, which never happens. And versus Mexico, the yields were very elevated,” Arno says. “There is almost a 100 percentile relationship between the spread of those two different markets versus Colombia.”
Much of this improvement in Colombia stems from the limitations imposed on free-spending politics.
“We thought that there were a number of cases where we would see markets very concerned about politics,” Arno says. “But what we saw are constraints on the politics, coupled with very attractive valuations, yields on the currencies that were going to be supportive, very attractive nominal yields in a number of these markets and then importantly, a tight central bank.”
Peru is in a similar situation. Its sovereign yields should have taken a huge hit from the ouster of Peruvian President Pedro Castillo in late 2022.
Indeed, Bruno Rovai, a sovereign debt strategist at Macquarie Asset Management in New York, says that investors were cautious in Peru after Castillo’s replacement, Dina Boluarte, entered amid widespread social protests. Investors worried about the fiscal ramifications of the new administration because a weak mandate would push her to increase spending ahead of the next election, set for 2026.
“That would change a little of the picture we had before because even under Pedro Castillo the fiscal complex was in check and overall debt levels barely moved,” Rovai says. “But what we observed is that fiscal execution continues to be very much in line with the fiscal curve. President Boluarte did not have to increase spending to secure her mandate.”
Despite the political and social turbulence in Peru, Rovai says that the “institutional framework has remained quite solid,” which is important for bond investment.
Peru’s 10-year bond yield fell to 6.9% at the end of June from 8% six months earlier, according to World Government Bonds.
Mexico has fared better than most countries in the region, with its 10-year bond yield declining less abruptly to 8.9% at the end of June from 9.3% six months earlier, the data show.
Carlos de Sousa, an emerging markets strategist and portfolio manager at Vontobel Asset Management in Zürich, says the politics in Mexico have been “much more stable than in the rest of the region.”
While Mexican President Andrés Manuel López Obrador, widely known as AMLO, is coming toward the end of his six-year term in 2024, “he still remains quite popular, which is a very unique feature from a political point of view in the region,” de Sousa says. “We have seen that with all the presidents in the region that get elected, the honeymoon period is over within six months and their popularity declines very sharply.”
Unlike many of his predecessors in Mexico, however, AMLO “hasn't had to spend a lot of money to keep his popularity,” he adds. “He has actually been effective at maintaining his popularity while at the same time implementing quite austere measures from a fiscal point of view. That's been interesting and unique for Mexico, and investors are obviously liking that.”
It helps that Mexico is the most integrated economy in the region with the United States, and this has boosted remittances flows into Mexico and exports of industrial goods to its northern neighbor. At the same time, a push to move operations from Asia to locations closer to the United States has boosted economic growth in Mexico.
While the relative fiscal stability in these countries has helped bring down bond yields, the big holdback for a pickup in bond investment in the region is when the US Federal Reserves will cut its benchmark rate, which has shot up to 5.25% from 0.25% over the past 15 months.
“Coming into this year there was a lot of hope that we would be seeing the peak of the cycle, and then those hopes have kind of been fluctuating ever since January between we’re going to see more hikes, see less hikes, see a pause, cuts,” Zouk says.
“Once there is a little bit of clarity on the Fed angle, I think Latin America could do very well. It’s a very good cyclical and tactical story,” he adds.
In the meantime, a few bright spots have emerged for investors in the region: Costa Rica, the Dominican Republic and Paraguay.
“Those are names that are in the double-B, single B range,” says Macquarie’s Rovai. “The transactions would be very positive if or when they come to market.”
On June 28, Paraguay sold $500 million worth of 10-year bonds in the international market in a deal that was 6.4 times oversubscribed. The sovereign priced the notes to yield 5.85% after opening the initial price talk in the low-6% area.
Zulfi Ali, a New York-based fixed income portfolio manager at PGIM, the investment management division of Prudential Financial, says he likes the Dominican Republic for “the business-friendly environment and policy consistency, even though we have seen a little slippage. I think the predictability of policy is very important in an environment where you have a lot of uncertainty.”
De Sousa adds that the Dominican Republic’s economy has become more diversified in the last few years.
“It’s not just a tourism country. They also have gold mining and a little bit of an industrial sector which is integrated with the manufacturing in the United States,” he says.
However, de Sousa warns that if the United States enters into a recession, that will hurt the island nation’s economy, including with a decline in tourism inflows, as it largely attracts middle-class tourists.
The Bahamas, by comparison, is “a high-end destination for tourism” that can sustain such inflows, de Sousa says.
This is one reason why The Bahamas is considered the brightest spot in the region, coupled with its fiscal performance.
“The Bahamas is one that is making efforts to improve its fiscal and taxation side of things,” says PGIM’s Ali.
De Sousa is of the same opinion. “I think the external bonds there remain very attractive at a yield of about 12% for its 2032 bonds, for example,” he says.
“They have been doing quite a good job in terms of fiscal adjustment, gradually but consistently. Tourism has recovered very strongly in terms of arrivals, but also the level of spending that tourists are doing is much higher than pre-pandemic,” he adds. “That is still a very good opportunity for investors willing to go off-benchmark.” LF