Ecuador Bonds Exit Distressed Ranks After Election-Day Surprise

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The victory of a career banker in Ecuador’s presidential election just made the serial-defaulting nation’s dollar debt a whole lot less risky. The question is whether it’ll stay that way.

The recently restructured bonds emerged from distressed territory after Guillermo Lasso was elected Sunday, stoked by investor optimism that the new government will shore up the economy and stick to fiscal austerity measures needed for a program with the International Monetary Fund. The problem is that he will face a fragmented congress, which could make governing a challenge.

The extra yield investors demand to hold Ecuador’s bonds narrowed to 860 basis points over U.S. Treasuries as of Thursday, from 1,169 basis points before the presidential runoff vote, according to JPMorgan Chase & Co. data. The move releases the nation from distressed status, which is typically reserved for sovereigns that trade at average bond yields of more than 1,000 basis points over Treasuries.

“Lasso is clearly a step in the right direction both for Ecuador and its relationship with debt markets,” said Victoria Faynbloch, a strategist at TPCG Valores, which recommended turning overweight on Ecuador bonds on Monday. “But we’ve seen that story many times, like in Argentina with Macri. Turning away from populism and rebuilding macro balances is a challenging, costly business.”

Former Argentine President Mauricio Macri took office vowing to return the country to foreign debt markets and end capital controls, but by the end of his presidency, volatility had led to a currency crisis and the election of leftist Alberto Fernandez.

Faynbloch expects Ecuador’s bonds to stabilize for now as investors mull how much of President-elect Lasso’s agenda will be enacted given the potential challenges in securing support in congress. Still, the bonds are “certainly not” going to plunge back to where they were before the vote, she said.

Ecuador Bonds Exit Distressed Ranks After Election-Day Surprise

Lasso’s win represents a pivotal moment for the country, just months out from its 11th default or debt restructuring in under 200 years of independence. He beat out economist Andres Arauz, a left-wing protege of former President Rafael Correa, calming investors who thought his opponent was likely to lead the country into insolvency once again.

Ecuador’s bonds due in 2030 led the rally in the wake of Lasso’s election, climbing 18 cents to 78 cents on the dollar since last Friday’s close, the highest since the notes were restructured last year. The 2035 bonds rose almost 15 cents, while the long-dated ones due 2040 were up 11 cents.

“I never recall something going up 30% in one day, and I’ve been doing this for a quarter century,” said Edwin Gutierrez, head of emerging-market sovereign debt at Aberdeen Asset Management Plc in London. “It does seem priced for perfection up here.”

Lasso’s party and its ally only hold 31 seats in congress, far fewer than needed for a 70-seat simple majority. This will become especially important for markets as the president’s agenda may include unpopular reforms supported by the IMF, Eurasia Group analysts Risa Grais-Targow and Laura Duarte wrote in a note.

“Lasso’s victory bodes well for investors given his orthodox policy preferences and his desire to continue working with the IMF,” they wrote. “However, Lasso will face immense governability challenges.”

Next Moves

Lasso has already promised to present a tax reform the night of his inauguration on May 24 that aims to scrap a 2% tax on small company sales, phase out a 5% currency export levy and fight tax evasion, particularly among the corporate sector in which he had a career as a banking executive.

Investors will also monitor meetings between the new government and current President Lenin Moreno’s officials to discuss the transition.

Central bank reform will also be a key “litmus test” for the ability to broker political alliances and would put negotiations with the IMF on a good foot, according to Siobhan Morden, head of Latin America Fixed Income Strategy at Amherst Pierpont.

“There is bias for positive headlines on IMF and Assembly relations and some breathing room” as there are limited bond payments in the near term, she wrote in a Tuesday note.

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