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Big asset managers are flocking to Latin American bonds and currencies, attracted by the region’s high interest rates, low inflation and more resilient economies than many had expected.
Latin America is home to five of the world’s top eight performing currencies this year, which have benefited from the region’s central banks acting early and decisively by raising rates and keeping them high even as inflation recedes. Total returns of local bonds have also surged ahead of their developed market peers, as chunky inflation-adjusted yields draw the attention of investors.
“With every month that passes the real yield is getting bigger and bigger,” said Paul Greer, emerging markets debt and FX portfolio manager at Fidelity. “So more and more investors want to put their money into Latin American currencies for that reason.”
Greer, whose portfolio is overweight in local currency bonds in Brazil, Mexico, Colombia, Peru and Uruguay, said that for both government debt and pure currency exposure, Latin America is “the place to be”. An exception, he said, was Argentina, which has been cut off from access to international markets after a debt default and where inflation runs at more than 100 per cent.
Latin American central banks took the fastest and most decisive action globally when inflationary pressures picked up in the wake of the coronavirus pandemic, which helped suppress price growth much more quickly than in other regions.
But high rates have not choked off economic growth. Brazil and Mexico — the region’s two largest economies by GDP and the most popular among international investors — both outperformed growth forecasts in the first quarter of this year, prompting economists to raise their projections for the end of the year.
In Brazil, the poster child for early and aggressive rises, annual inflation is now under 4 per cent, down from more than 13 per cent this time last year, while interest rates have been kept high at 13.75 per cent since August 2022. In Mexico, rates have been held at 11.25 per cent since March with headline inflation falling to 6 per cent in May.
“In places like Brazil or Mexico, now you’re talking 6 per cent and 4 per cent real yields, based on where inflation expectations are, which is a really compelling argument to be adding to those currencies,” said Iain Stealey, chief investment officer of global fixed income at JPMorgan Asset Management.
“Is it a crowded trade? Has everyone piled into it? I don’t think that’s the case yet,” Stealey said, adding foreign ownership of local emerging market bonds is still low following the pandemic and multi-asset investors “haven’t yet moved into emerging market debt”.
Part of the reason investors are being drawn back to Latin America is that market nerves over leftwing governments in Brazil, Chile, Colombia and Peru have been calmed by a lack of congressional majorities that have left them unable to implement many of their policies.
And central banks have maintained their independence, ignoring calls from President Luiz Inácio Lula da Silva in Brazil and President Andrés Manuel López Obrador in Mexico to cut interest rates, arguing that it stifles economic growth.
“Despite all the bluster from the politicians, it has not impacted central bank decisions,” said Geoffrey Yu, senior foreign exchange strategist at BNY Mellon.
Yu said another reason for the success of Latin American currencies and bonds in 2023 was years of foreign investors avoiding the region. “There’s been practically no positioning — so it’s an easy trade. It’s a good time to buy bonds before central banks start cutting rates.”
The worry for currency investors now is that the rally will run out of steam as central banks start cutting rates ahead of other regions. Chile is poised to start lowering this month, investors say, followed by Peru and Brazil in August and Colombia and Mexico by the end of the year.
Daniel Ivascyn, chief investment officer at Pimco, said: “At these levels we have a little less conviction on the [Mexican] peso, which has had a combination of very strong performance and relatively low volatility.”
But he said bonds in Mexico and Brazil “are starting to look interesting” as inflation pulls back and the prospect of rate cuts draws closer. “They understand the cost of being late on inflation. At least the opportunity for more sustained performance is there,” he said.
While some investors say the Mexican peso is starting to look overvalued, if central banks cut rates slowly, currencies across the region could continue to perform well. Greer said he is still betting in the major South American currencies because “inflation will continue to fall faster than central banks will dare to cut interest rates”.
Mexico in particular has some attractive long-term structural advantages, as key beneficiary of “friendshoring” of US companies out of China to lower-cost, closer labour markets, and a surge in remittances boosted by a tight US labour market. It also has among the most stable finances in the region, boosted by fiscal restraint in response to the pandemic, but is one of the most sensitive emerging markets to any slowing in the US economy.
Despite the risks, Jim Cielinski, global head of fixed income at Janus Henderson, said emerging and developing markets in general “look much better positioned in aggregate than their developed market peers”.
“We would expect the Mexican peso and Brazilian real to be higher by the end of the year,” he said.
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