Latin America’s bonds are poised for a comeback in 2023, with investors planning the perfect moment to pounce on bargains before a Federal Reserve pivot and China’s reopening send them soaring.
Dollar-denominated debt from Latin American governments and companies has handed investors returns of more than 10 percent so far this quarter, outperforming all other regions in an emerging-market index that has returned seven percent in that period. China’s move away from Covid Zero, the potential end of the Fed’s interest-rate hiking cycle and quieter politics could all help the region’s notes shine even brighter in the new year.
“Latin America will be one of the most favoured regions, and as a result, sovereign credits should perform quite well,” said Graham Stock, a strategist at Bluebay Asset Management in London, who favours cheap bonds from Ecuador and Argentina. “Growth in China is likely to accelerate in 2023. High commodity prices and increased Chinese demand add important support for the region.”
Large commodity exporters such as Brazil, Chile and Peru should benefit from increased demand from China as Beijing shifts away from its Covid Zero policies and stresses government support for its beleaguered property market. The region is also less exposed to Russia’s war in Ukraine, which will likely continue to weigh on emerging European credits.
“Latin America is not a screaming buy, but we do expect some modest outperformance,” said Jared Lou, a portfolio manager for emerging-market debt at William Blair Investment Management in New York. “Even if we’re no longer in the commodity super cycle, we are still constructive on commodity prices due to supply constraints and expectations of China reopening.”
According to Lou, Latin America’s debt will benefit the most among emerging markets from lower volatility in US rates, as it has a longer duration — a measure of sensitivity to fluctuation in interest rates.
Debt from the region has an average duration of 8.1 years, compared to 6.9 years for JPMorgan Chase & Co’s developing-market sovereign debt index. Africa’s debt has an average duration of 5.4 years, while Asia stands at 6.7, Europe at 5.3 and the Middle East at 7.2.
Risk ebbs
Political risk may take a back seat in the year ahead. None of the region’s main economies has presidential elections scheduled until October, when Argentines will choose a new leader.
In Brazil, traders are hoping President-elect Luiz Inácio Lula da Silva’s government will be fiscally responsible, even if his finance minister pick isn’t a market darling.
Investors have also warmed up to Colombia’s Gustavo Petro, who’s proposed to halt oil exploration and sell bonds to fund land purchases, as the nation’s bonds are too cheap to pass on, according to Zulfi Ali, a money manager at PGIM Fixed Income in Newark.
“The risk is that the market unfriendly policies persist, but so far they’ve tended to pivot toward what the market expects,” said Ali, adding the firm has a small overweight on the region’s corporate bonds. Other corners of Latin America, such as the Dominican Republic, he said, are also attractive as political risk is “quite small.”
Investors also see little risk of a default in El Salvador in 2023, where Nayib Bukele’s policies have sent the sovereign debt into a tailspin. The nation’s bond due in January has been edging closing to par.
And even in Peru, which just swore in its sixth president in four years, investors are soothed by relatively strong fiscal and external positions, as well as the new president’s pick of a US-educated former central bank economist as finance chief.
Since late October, when the sell-off in emerging-market dollar bonds halted, Latin America has seen the smallest relative narrowing in spreads among the five regions. That suggests there’s scope to contract further, especially given the possibly improving political climate.
“All in all, political risk will be little a bit less pronounced next year,” said Sarah Glendon, a senior analyst at Columbia Threadneedle Investments in New York. “Even if the market doesn’t like who we have, the market knows who we have in office in most major Latin American economies.”
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by Maria Elena Vizcaino & Leda Alvim, Bloomberg
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