South American Local Bonds Are Getting Battered From All Sides
(Bloomberg) -- South American local-currency debt has been a painful place for international investors lately and there’s little sign of immediate relief.
Rising inflation risks, central bank rate hikes and fiscal concerns have been adding upward pressure to yields across much of the region, while currencies have been buffeted by a combination of political concerns, sliding commodity prices and the resurgent Covid threat.
Peru, whose new left-wing president has caused jitters among investors, is the year’s worst performer in a Bloomberg Barclays index of emerging-market local-currency debt that measures returns in dollar terms. Its bonds have fallen 27%, with Chile and Colombia the next biggest losers. Brazilian debt has taken a hit in recent weeks, driving it to a decline of around 5% this month, the second worst showing in the region after Peru.
“The pandemic has hit Latin America harder than other emerging-market regions, which has been reflected in the bigger fiscal pressure and political turbulence,” said Mario Castro, a strategist at Banco Bilbao Vizcaya Argentaria in New York.
A loosening of fiscal policy aimed at fighting the worst economic effects of the Covid pandemic has been a significant factor in the rout. In Chile, a widening of the deficit is weighing on peso-denominated bonds this year. International Monetary Fund figures show the country has been the biggest spender on Covid aid among emerging markets, forking out around 14.1% of gross domestic product, and the government this month said it would extend emergency cash payments to poor and middle-class families.
Related story on Chile’s bonds and fiscal situation
There have been similar moves in Brazil, with the government revamping and increasing payments to needy individuals and families as President Jair Bolsonaro gears up to seek re-election next year. And with inflation risks a concern for central banks around the world, that’s adding to the pressures faced by policy makers. The central bank in Brasilia has so far lifted its benchmark by 3.25 percentage points to 5.25% since March and swap markets suggest that officials might continue to accelerate their tightening.
In Peru, meanwhile, a weakening of the local currency and consumer-price gains led officials in Lima to lift the country’s key lending rate last week for the first time in half a decade.
Chile also started to lift rates last month and investors are bracing for Colombia to follow suit, possibly as soon as the central bank’s next meeting at the end of this month.
Outflows, along with higher inflation, are pressuring central banks to hike rates across the region, where growth remains below its pre-pandemic levels, said Armando Armenta, an emerging-market strategist at AllianceBernstein in New York.
Political imbroglios throughout the region have added to market volatility and in many cases taken a chunk out of currency valuations. The ructions in Peru surrounding the new president, which this week helped push the sol to another record low, are one example. The Colombian government’s attempt at tax reform earlier this year collapsed in the face of massive street protests and the Brazilian president has been ensnared in various scandals.
Such discord may also help to undermine confidence that governments will ultimately be able to return to a less-expansive fiscal policy, according to AllianceBernstein’s Armenta.
In Chile, traders are becoming increasingly more sensitive to opinion polls that show candidates neck and neck in the race for the presidency. Three-month implied volatility on the peso is currently hovering at around 14%, close to the highest levels this year, as investors look to hedge against the kind of swings that recent polling has spurred.
Even if the decline in currency valuations comes to a halt, the recent uptick in volatility across much of the region may be enough to make fixed-income investors cautious, potentially pushing them toward either higher-yielding emerging-market peers or lower-risk assets.
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