The Big Idea
Latin America | Assessing external shock
This material is a Marketing Communication and does not constitute Independent Investment Research.
Low dependence on external capital and reasonable economic buffers should reduce vulnerability in certain Latin American sovereigns to downside growth risk if oil prices remain high. These point to better relative value in oil exporters such as Ecuador and Argentina and also highlight the value of diversification for select ‘BB/BBB’ credits such as Costa Rica and Panama with upside if US Treasury debt strengthens.
Uncertainty has pushed many emerging markets issuers and investors to the sidelines with limited bond issuance in the last month and weekly outflows from emerging markets hard currency bond funds and ETFs. The $19 billion in emerging markets issuance in March was the lowest over the past 25 months and far below trend monthly issuance of $51 billion. There were a few opportunistic issuers with ‘B’ rated Angola coming to market during a moment of reprieve with $2.5 billion in high yield issuance just below 10%. This was still at an early phase of uncertainty and reflected core support for oil exporters. There is (yet) no specific credit in Latin America vulnerable to losing access to external capital, helped by lower external financing needs and limited domestic financial contagion. There is less rollover risk for credits like Argentina due to its lower financing needs—so long as domestic financial contagion remains low—and Panama due to the diversification of its financing sources and investment grade rating
No credit escaped total return losses from the one-two punch of both US Treasury and equity weakness and with the EMBIG down 3.4%. The low yielders were mostly vulnerable on their higher sensitivity to US Treasury contagion. The higher yielding oil exporters were mostly the outperformers including Colombia, Argentina, and Ecuador within the EMUSTRUU index, a blend of sovereigns and corporates. The high yielders experienced an orderly upward shift across their curves—as opposed to distressed bear flattening. The timing was also ideal for Colombia as political risk premiums fell and as idiosyncratic domestic risk dominated external risk.
No credit looks immune to the downside risks to growth from a protracted oil price shock. However, the oil credits would benefit from additional petrodollars to mitigate the hit to the real economy. Argentina has been my preferred high yielder assuming supportive external growth. Under a less supportive external backdrop of weaker global growth, Ecuador would probably be the least vulnerable due to its low liquidity risks and low dependence on external capital. This should encourage adding exposure to Ecuador depending on the intensity and duration of the external shock.
Latin America as a regional oil exporter was resilient compared to other emerging market regions. This resiliency was noticeable for even select Central American credits that benefit from either policy flexibility and liquidity buffers (Guatemala) or potential for positive growth (Panama). I have been recommending the shorter tenors in Panama relative to Peru and the intermediate sector of the Guatemala curve. There has been no visible contagion to Central American local markets due to their illiquidity and market segmentation and low funding needs. The stable foreign exchange rates should help mitigate the inflationary shock with higher policy flexibility to counter downside risks to growth including moderate fuel subsidies and monetary stimulus.
Despite lagging performance last month, Costa Rica remains my top pick. It has positive rating momentum from its active reform agenda in the second half of this year. This should raise potential for rating upgrades. Stronger rated credits are well positioned to manage the fallout from protracted high oil prices with lower inflationary risks from an even stronger foreign exchange rate. Guatemala and Costa Rica coincidentally benefit from below-trend inflation, above-trend growth and more than 10 months of import coverage on foreign exchange reserves. Panama may also benefit from a positive shock to growth with an activist policy stance to negotiate the mine re-opening with now higher motivations to counter the downside risks from the oil shock.
These ‘BB’ credits less likely to track broader market moves may provide some defense under a scenario of higher oil prices for longer. This suggests an investment pivots from indiscriminate high carry trades towards diversification that benefit from more US Treasury exposure and less market beta. There is still a case for the select high yielders, specifically the oil exporters like Argentina and Ecuador. These credits are both benefiting from a structural economic shift on fiscal consolidation and economic reform with help from an IMF anchor. If the oil shock continues, relative value shifts further toward Ecuador.
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