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Elections in '06 Signal Volatility for Latin America LONDON (By Rodrigo Davies, Bloomberg News) December 28, 2005 Latin American bonds provided the best returns in 2005 among emerging-market debt securities, rallying for a third year. But some investors are betting the boom will end in 2006 as voters across the region choose new governments. "The uncertainty over what all the elections will bring in terms of economic policy will hold Latin American debt back next year," said Jonathan Binder, a managing director at the INTL Consilium hedge fund in Fort Lauderdale, Florida. "We're nearing the point where there's not enough extra reward for investing in these markets." Binder is using swaps, put options and other derivative contracts to bet on a drop in prices for the region's bonds, figuring that politicians will be less likely to woo foreign investment and cut spending with elections looming. Brian Coulton, a director of sovereign ratings at Fitch Ratings in London, agreed. "A lot of countries' economies have done very well on rising exports, but they haven't been as successful in improving their budgetary situation," he said. "Latin America is heavily indebted, and the political cycle can be quite volatile, so there's a chance of some setbacks there." For now, though, pessimistic investors are in the minority. Surging commodity prices raised exports to record levels in Brazil, Mexico and Argentina. The region has five of what have been the world's 10 strongest currencies against the dollar this year. And some leaders have cut deficits, like the president of Brazil, Luiz Inαcio Lula da Silva, and of Chile, Ricardo Lagos. The extra yield that investors demand to hold the debt of Latin American countries instead of U.S. Treasury securities has declined about 1.43 percentage points this year, to 2.77 percentage points, according to J.P. Morgan Chase's EMBI+ index. The spread in November reached its narrowest ever, 2.73 percentage points. Global emerging-market spreads have narrowed 1.14 percentage points, to 2.42 points, the index shows. The yield on Mexico's 9 percent local-currency bond due in December 2007 has fallen almost a full percentage point this year, to as low as 7.75 percent on Thursday, according to Banco Santander Mexico. The yield to maturity on Brazil's benchmark 11 percent bond, due in 2040, has dropped 79 basis points, to a record low of 8.43 percent, according to J.P. Morgan Chase. Yet that could change if governing parties in Brazil and Mexico, the region's two largest economies, lose control in presidential elections next year. In Peru, a former rebel leader, Ollanta Humala, who advocates nationalization of mines and expulsion of foreign companies, was running second in Peru's presidential race, a poll this month showed. Elections are also scheduled in Venezuela, Colombia, Nicaragua and Costa Rica. Bolivians this month elected Evo Morales, a leader of coca growers who has vowed to increase state control over the economy and seek forgiveness of the country's $4.9 billion of international debt. Binder, a former chief investment officer for emerging markets at Standard Asset Management, said the yield premium offered by Latin American debt could rise as much as two percentage points next year. That would be the biggest jump since 1998. Oil and copper prices have risen to record levels and aluminum has hit to a 16-year high, aiding growth in countries that produce those commodities, like Mexico, Chile and Brazil. In Brazil, da Silva faces a challenge from the mayor of Saυ Paulo, Josι Serra, in an election in October. The president's popularity is at a low point, amid investigations into allegations of government corruption. Brazil under da Silva has cut its deficit to 3.3 percent of gross domestic product, from 5 percent when he took office in January 2003. In Mexico, Andrιs Manuel Lσpez Obrador of the Party of Democratic Revolution is ahead of Felipe Calderσn, the candidate of President Vicente Fox's National Action Party, in opinion polls. Lσpez Obrador has said he will block further state asset sales and slow efforts to open the economy to more private investment. "It's hard to believe that any of the candidates in Mexico's election are going to pursue the kind of tax reform and widening of revenue that the country badly needs," said Paul McNamara, who manages emerging-market assets in London at Julius Baer Investment Management. "We're expecting lower returns and more volatility from Latin America next year." Some investors, though, doubt that new governments would risk damaging the confidence of foreign investors by greatly increasing spending. "Any spread-widening we see isn't likely to last too long," said Christian Kopf, who helps manage emerging-market debt at DWS Investment in Frankfurt. "Although it's quite likely that left-wing candidates will win in most countries, we've seen remarkable successes in the past few years, and there's no reason to believe these new governments won't be responsible." Kopf said the extra yield offered by Latin bonds could reach 3.6 percentage points before narrowing to 2.7 percentage points by the end of the year. He added that he would use declines as an opportunity to buy debt. |
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