LATAM bonds: they see opportunities in the face of a possible Fed rate cut

Fixed income in LATAM has recorded a poor performance so far in 2024but the projection that the US Federal Reserve (Fed) will lower interest rates this month could changing the outlook for these sovereign bonds. In line with this dynamic, it is that The iShares JP Morgan USD Emerging Markets Bond ETF (EMB) had a strong month in August, gaining 2.3%.

“In 2024, the region’s bonds suffered more than the rest of the emerging markets”he told Scope Eric Ritondalechief economist at BRIDGE and explained that The spread on LATAM bonds had been falling steadily in the first quarter (they lost 58 basis points at the beginning of the year compared to US Treasury bonds). However, “From May onwards, emerging bonds were hit harder. On average, LATAM bonds jumped 95 pp in spread, and now have an average of 468 pp,” Ritondale added.

But The heterogeneity of the countries also had an impact. “Now this movement in the aggregate spread of LATAM bonds is mainly explained by the negative performance of higher risk bonds such as Argentina, Ecuador, El Salvador or Bolivia. These were particularly affected in the second quarterwhile they stopped compressing against the rest.”

Despite this, They had been the best performing bonds in LATAM (Argentina, Ecuador and El Salvador, excluding Bolivia) in the first part of the yearaccording to the Puente expert, to a large extent, “supported by stories that at an idiosyncratic level were of improvements in the fundamentals of the countries, and at an external level by a compression of global risk that favored this class of assets.”

Fed rate cut: how it will impact LATAM bonds

Last week it became known that Inflation remained stable in July in the United States, at 2.5% in the 12-month measurementand the prospects are growing that the Fed cuts interest rates in mid-September.

It should be noted that the organization led by Jerome Powell raised rates to levels not seen in more than two decadesto make credit more expensive and thus discourage consumption and investment after the pandemic, such as way to moderate pressures on prices. The Fed is seeking to keep inflation at 2% per year. Currently, benchmark rates are in the range of 5.25-5.50%, the highest in 23 years.

“Generally speaking, We have a positive expectation for the region’s sovereign fixed income for the short, medium and long term. product of the highest rate level in the last 15 or 20 years,” he told this newspaper, Juan Cruz Lekovic, CFA Fund Manager of Schroders.

“In turn, in general terms, It could be thought that the beginning of a Fed rate-cutting cycle, and consequently rate cuts across the entire US sovereign curve, is a positive driver. for Hard Currency Sovereign debt. However, The reasons that drive this drop in rates may imply better or worse performance”broad.

In which cases opportunities open up for LATAM bonds

To arrive at two possible scenarios, Lekovic first detailed The three components of the return on hard currency sovereign debt. And he detailed: “the ‘carry’ that depends on the initial level of ratesthat is, the level of rates seen today, the risk-free rate that dependsin part, from the Fed’s monetary policy rate and expectations about the decisions it may take in the future and the credit risk spreada default risk component that is explained, in part, by systemic risk and idiosyncratic risk.”

“If the US rate cut is driven by an American economy entering recession (which would imply a faster rate cut than the market expects), We could see a risk-free rate compressingbut that effect was partly offset by a widening of spreads. On the contrary, If the rate cut is gradual due to a slowing US economy and inflation in line with the Fed’s target, We could see spreads holding and even compressing”the expert expanded Schroders.

In a scenario of “soft landing”therefore, explained that “positioning in the short or middle part of the curve could be more attractive, while in a ‘hard landing’ scenario it may be more attractive to have a bit more duration.”

Finally, he warned that This analysis must be added to the specific opinion of each country to evaluate how the idiosyncratic risk of each one can impact the spread of rates.“The region in general, with some nuances, appears to have solid fundamentals and that is why we have a positive view for the asset class in the short, medium and long term,” he concluded.