Latin America’s new issues swing between low rates and potential recovery

Dan Barnes Welcome to Primary Markets TV – your insight into the newly issued securities across equity and fixed income spaces and bonds. Joining me today is Erik Norland, senior economist at the CME. We’re going to be looking at Latin America today and specifically how currency and interest rates action might affect bond portfolios. Erik, welcome to the show.

Erik Norland Thank you so much for having me.

Dan Barnes So tell us, how do you expect Latin America’s interest rate and currencies to behave over 2021?

Erik Norland I think that the interest rate markets, first of all, are starting to send a really positive signal for what investors expect to have happen in their economies. And that is especially true in Brazil, where the yield curve has deepened to some of the steepest levels that we’ve ever seen in the past decade and a half anyway. We also have very steep yield curves in Chile and in Colombia as well, which is a sign that investors are very optimistic about the animal spirits and the prospects for economic recovery. Mexico’s yield curve is also very steep, and it’s not anywhere near a historical high in terms of steepness, but people have become more optimistic there. Mexico’s economy is very closely tied to the US, which is its main export market. Mexico also has a very different economy than the other countries in the region. What the fixed income markets are telling us is basically that the economy there have been hard hit. Central banks have slashed interest rates, but the people are thinking the economy will recover and eventually short term interest rates will lift off, again.

Dan Barnes Picking up on that point about the economies, which factors are you expecting to be impacting them over the next year?

Erik Norland Latin America really has two issues there. First, the state of their domestic economies, which have been very negatively impacted by COVID-19. So the pace at which they get the vaccine out and the pace at which the pandemic hopefully starts going away will matter a great deal to the course of their economic activity. But then secondly, also the state of the international economy, how are their exports going to do? And what’s curious, I think, about Latin America is that especially in the cases of Chile, Colombia and Brazil, their export prices have soared.

A lot of the raw material prices have gone way, way up, whether it’s oil or soybeans or iron or copper, in the case of Chile. So their export prices are really high, but they can’t even match those in terms of the volume of demand coming from the rest of the world. When their currencies are kind of decoupled from the export prices in the last year, which is also kind of novel for them. Normally, at least up until the pandemic, their currencies moved in lockstep with baskets of their exports that are traded on exchanges. And that completely diverged last year. Export prices soared, but their currencies did not. And that also means that they can produce these goods really cheaply compared to the rest of the world, which gives them a big competitive advantage.

Dan Barnes How do these factors potentially impact existing fixed income investments versus newly issued bonds?

Erik Norland I think the steepening of the yield curve obviously means that short-term interest rates are very low compared to the longer term interest rates. So the existing bonds have mostly profited from price appreciation. So, you know, I guess if you’re an issuer, you can issue short-term debt pretty cheaply, and that’s especially the case, of course, for governments, and also presumably true for a lot of private sector actors as well. But when you issue debt further out on the yield curve, that is a little bit more expensive, because people are anticipating that economic recovery and they are anticipating their short-term rates are most likely to go back higher eventually.

Dan Barnes If we then take that to existing bond portfolios, what do you think the impact might be and what should investors be considering as an outcome?

Erik Norland I think one thing to be aware of is that central banks in Latin America might be in a position where they cannot lower short-term interest rates much further. In the case of all four central banks, they have their short-term interest rate kind of at or even below the rate of inflation. So that actually puts them in a situation much like their North American and European counterparts. So I guess further up the yield curve, when you look at the longer term bonds, one thing to consider is that if economic weakness were to last, there is some possibility you could see further price appreciation on that part of the yield curve. One thing we’ve seen in Europe and North America over the year is that long term yield curve sometimes anticipate rate hikes that either don’t happen or take a lot longer to happen in the market that initially believed that they will happen. That’s something that investors might want to take a look at.

Dan Barnes Erik, thank you so much for your time today. Really appreciate it.

Erik Norland Thank you so much for having me.

Published on April 8, 2021