The Big Idea

Latin America | Finding relative value

| June 23, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Emerging markets debt along with other risk assets is tightening to the US Treasury curve, and relative value is shifting in Latin America. Potential returns in The Bahamas and Costa Rica look promising. El Salvador may not be able to stay on its impressive year-to-date pace of 58% total returns. And Ecuador looks likely to lag behind its high yield peers.

The Bahamas: Laggard Bounce

The Bahamas has experienced a significant shift in fiscal data, moving from a deficit to a surplus in the first quarter of 2023. Unlike other countries in the region, tax revenue in The Bahamas is booming, leading to stronger-than-expected results for the fiscal year. However, challenges lie ahead as the country aims to reduce a deficit of 3.8% of GDP and bring revenue and spending into balance. The high debt ratio of 83% of GDP leaves no room for error. If external risk remain at bay and fiscal data meets expectations, the yield curve is likely to bull steepen from its current flat-to-distressed levels. Bonds maturing in 2028 and 2029 may outperform, particularly with an upcoming amortization in January 2024. The Bahamas has been the second top performer in the region, with impressive year-to-date total returns of 6.2% for the EMUSTRUU index. Despite its high yields of approximately 12%, The Bahamas benefits from lower event risk compared to countries like Argentina and Ecuador. Recent headlines about a potential debt-for-nature swap could lead to catch-up gains for The Bahamas.

Costa Rica: BB Convergence

A recent rate cut in Costa Rica serves as a reminder of the country’s strong fundamentals. With inflation below trend and still leading in terms of growth among regional countries, Costa Rica’s fiscal performance remains robust. Further rating upgrades may be on the horizon, as the country maintains a 2% of GDP primary surplus this year. Valuations have become a key point of discussion following Costa Rica’s full convergence to the illiquid BB peer group. Relative supply risk becomes a factor as Guatemala recently completed its funding needs with a $1 billion Eurobond, while Costa Rica plans to issue $1.5 billion in the second half of 2023. Although recent profit-taking has led to underperformance, the supply is not expected to disrupt the strong fundamentals of Costa Rica. Real money European and crossover investors hold core underweight positions, and there is still confidence that the country can trade close to its peer group. In the long term, Costa Rica is on track to reduce its debt burden to around 40% to 50% of GDP, positioning itself for an investment grade rating.

El Salvador: Paying for Much Longer?

El Salvador continues to experience a rise in prices driven by supportive technical factors. With impressive year-to-date total returns of 58%, El Salvador leads among emerging markets. The country benefits from high carry and low event risk, while liquidity management remains strong after debt buybacks and pension reform. Recent headlines suggest plans for a $1 billion domestic debt exchange, swapping short-term bonds (LETES/CETES) for longer tenor bonds. The current bond prices, which have surpassed initial targets and reached the 60s, indicate payment capacity beyond 2027 and higher recovery values. While the technical factors continue to support an overweight recommendation, the conviction is lower due to the impressive year-to-date returns and less favorable risk and reward at higher bond prices. Avoiding default requires further fiscal consolidation throughout the current economic slowdown and in preparation for the general elections next year. Achieving fiscal consolidation is a gradual process that requires consistent effort, including cutbacks of transfers from downsized municipal governments.

Ecuador: Frontrunner Candidates

Eurobond prices in Ecuador remain stagnant as investors await clarity on the political and policy risks leading up to the general elections. There is skepticism regarding the potential for a heterodox policy bias under Correismo or weak governability during a moderate political transition. The country faces challenges due to its culturally leftist political establishment and a dollarized economy. Recent setbacks, such as the rejection of an urgent economic decree for a free trade zone by the constitutional court, highlight the broad-based resistance to economic reform. The lack of discussion regarding a medium-term economic plan to finance debt amortizations beyond 2025 adds to the concerns. The base case scenario includes an opposing candidate winning against Correismo in the runoff round in October. The first polls, to be released soon, will provide insights into voter preferences and the potential candidate to face Correismo. The most likely scenarios suggest weak governability under a moderate candidate, prioritizing politics over economics for a short 15-month interim mandate. Until there is a shift toward economic reform or fiscal discipline, Ecuador’s bond prices are expected to lag behind its high-yield peers during the recent rally.

Siobhan Morden
siobhan.morden@santander.us
1 (212) 692-2539

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles