Ecuador’s Divisive Presidential Vote Has Bondholders on Edge

(Bloomberg) -- Investors are bracing for an unpredictable run-off finale to Ecuador’s contentious presidential race as opinion polls flag a rally of support for career banker Guillermo Lasso, sending the nation’s dollar bonds back to levels seen before the election began.

Voters will return to polling stations on Sunday to decide between self-exiled former socialist President Rafael Correa’s 36-year-old protege Andres Arauz, or Lasso, a banker and conservative from the coastal hub Guayaquil. It’s a high-stakes choice for the country and its bondholders, coming just months after Ecuador’s 11th default or debt rescheduling in almost 200 years.

Arauz held a double-digit lead in the initial voting round in February, but recent polls show Lasso has closed the gap. This may be leading investors to adopt more neutral postures heading into the vote, even as many voters remain undecided, said Siobhan Morden, head of Latin America Fixed Income Strategy at Amherst Pierpont. Adding to the confusion, the Indigenous political party Pachakutik has called on its supporters to spoil ballots amid fraud accusations.

“The bottom line is that the latest polls warrant a neutral position on what we view as equal binary outcomes and policy risks,” Morden wrote in a note. “We had previously argued the potential for extreme heterodox policies under an Arauz candidacy and now shift our analysis to the opposite orthodox policy risk under a Lasso candidacy.”

Read the QuickTake: Why Ecuador’s Runoff Vote Matters for the Bond Market

With so much up in the air, Ecuador’s recently restructured dollar bonds are near levels seen around the first round of voting in February. The notes due in 2040 have risen from an early-March low to trade at 45.5 cents on the U.S. dollar, just off the highest since the final trading day before February’s vote. Still, they’re down about 13 cents from last year’s restructuring, and slipped less than half a cent since Tuesday. The nation’s bonds, on average, are the fourth worst-performing emerging-market debt this year in a Bloomberg Barclays index.

“Asset prices have reflected optimism for a Lasso victory this month as Arauz has opposed the central bank reform bill currently making its way through the national assembly,” Citigroup Global Markets Inc. strategists including Eric Ollom and Donato Guarino said.

The increased possibility of a Lasso win makes the bonds maturing in 2040 a buying option as “they would be poised for the largest upside regarding current prices,” Ramiro Blazquez and Bruno Gennari of Buenos-Aires based BancTrust wrote in a research note.

The extra yield investors demand to hold Ecuador’s sovereign dollar bonds over U.S. Treasuries is 1,168 basis points, putting the nation in distressed territory alongside countries such as Argentina, Belize and Lebanon, according to JPMorgan indexes.

Final Round

At stake in Sunday’s vote is the next government’s willingness to honor the terms of last year’s $17.4 billion debt restructuring and whether it can maintain fiscal targets required under a $6.5 billion deal inked in September with the International Monetary Fund. The new administration will also need to prop up Ecuador’s sputtering economy, which contracted 7.8% last year and may grow just 3.1% in 2021, according to the country’s central bank.

While Lasso’s momentum in the polls has stoked speculation that he could pull off a victory, it’s still unclear if he’d be able to garner legislative support for austerity measures. Neither of the candidates will have a congressional majority if they win.

“The fragmentation of the National Assembly together with the strong legislative influence of the left would make governability extremely challenging,” according to Blazquez and Gennari.

Meanwhile, for Arauz, investors are split on whether he’d replicate Correa’s policies, which included a weakening of institutions, crackdowns on opponents, limiting freedom of expression and running large deficits. The candidate has adopted a more conciliatory tone in talks with bondholders, saying he’s committed to dollarization and to not restructuring the debt. However, he also continues to insist he will distribute $1 billion to poor families from the central bank’s scant reserves.

“While the election is looking more competitive, Arauz retains an edge,” Eurasia Group analysts Risa Grais-Targow and Laura Duarte wrote in a note this week. “Ultimately, he represents a clearer change in economic policy, but he will also have to contend with anti-Correista sentiment, making for a close contest.”

WHAT TO WATCH

• Brazilian traders will keep an eye on talks to resolve the 2021 budget gridlock, which has been one of the most significant local drivers this month. President Jair Bolsonaro signaled he may be leaning toward a partial veto of the bill approved by Congress, as requested by Economy Minister Paulo Guedes, but the situation may still change
• Brazil’s February retail sales due on April 13 may offer a fresh outlook on how the country’s economy is behaving amid increased coronavirus cases and the outlook for higher rates in the near term
  • Colombia retail sales are also due next week, on April 15
• Both Colombia and Chile have significant parts of their populations in lockdown in an attempt to fight the spread of Covid-19. Chile traders remain focused on the mid-term copper outlook as the commodity continues to favor local assets amid an improvement in the country’s current account balance
• Peru will hold its presidential election on April 11. The local market has been boosted by rising odds that market-friendly candidate Hernando de Soto will advance to the second round. Volatility should appear on Monday independent of the result

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