Latin American markets fared relatively well in the first half to this year.
a. First, issuance of international bonds had a strong start to the year. This was primarily driven by the public sector as non-financial corporates, on the other hand, cut back on their issuance.
b. Second, Latin American equities in U.S. dollar terms outperformed the MSCI emerging market index by some 10-percentage point on the back of resilient growth and currency appreciation. Indeed, many large economies in the region, with the exception of Argentina, experienced gains in the range of 5 to 20% against the dollar during that period.
c. In turn, the combination of appreciating currencies and higher local government yields provided significant incentives for carry trade flows into the region – most notably in Brazil, Mexico and Colombia.
The second half of the year so far has been more challenging
a. Even if somewhat more moderate, the region has not been immune to the sell-off in EM which saw portfolio investments by non-residents register outflows of close to USD 30 bn in August and September, according to estimates by the IIF.
b. But aside from softening growth in many economies, outflows from the region were primarily driven by global factors
- The first push factor has been the faltering recovery in China and the massive equity sell-off from the country by non-residents. This has weighed on Latin American stock performance as many stocks in the region tend to exhibit a higher correlation with Chinese equities due to the strong demand for commodities by China.
- The second push factor, perhaps more critical, has been the rise in US long-term yields. The latter reached highs not seen in 15 years as investors have become convinced that higher rates are there to stay.
This has two effects on Latin America:
- The first is that it redirects portfolio flows out of the region and into the US bond market as investors get a better return for less risk. This in turn strengthens the dollar and weakens Latin American currencies although some countries such as Colombia, Mexico and Brazil managed to hold on to some of their gains from earlier in the year.
- The second effect stems from the vital role that the 10-year Treasury yield plays as a benchmark in financial markets. When it rises, it increases the cost of dollar funding both through higher coupon rates and a stronger dollar.
This situation is likely therefore to have an adverse impact on international bond issuance in the region at a time when countries are looking for external financing to fund their energy transition. Point in case, this year alone 1/3 of all issuances in the region have come from green, social, sustainability linked bonds, which was a record. The current context suggests, however, that this trend is likely to be disrupted.
