LatinFinance - July 2013 - 14

US rates

Seeking solace

removal]. But if the currency is going to
be more stable, the absolute levels are also
pretty attractive.”
But the story for local currency debt
is far from clear, especially as emerging
market currencies depreciate against the
dollar. Says Capital Economics: “the best
days for EM local currency bonds may
now be over.”

The $2.5 trillion question

Looming large is the drama that unfolded
in 1994, when the nascent world of

©REUTERS

As dollar bond markets turned sour
in June, borrowers and investors
were already finding other pockets of
opportunity.
Falling local currencies and an
improving US outlook would favor
Latin exporters that are paid in dollars,
says Axel Christensen, chief investment
strategist for Latin America at BlackRock.
“We have to do the homework and look
at company fundamentals, but definitely
those that are more oriented towards

Bernanke: keeping the questions coming
selling products in dollars – they might be
exporters most commonly – and having
a local cost base should probably be in
better shape than others.”
Niche markets in Japan and
Switzerland offered succor to Latins
unable to print deals in dollars. And some
investors still saw value in a handful of
Latin America’s local markets. In the
context of a market sell-off, Brazil was
the best of Latin local currencies, says
Schroders’ Barrineau. Despite the severe
pressure on the real, the scrapping by the
government of a tax on capital inflows had
made it cheaper to buy.
“The central bank is intervening to
create a floor for the currency going
lower,” he says. “There’ll be some back
and forth there [following the IOF tax

14 LatinFinance

July 2013

emerging market debt was torpedoed by a
sudden 300 basis point hike in short-term
Treasury rates.
The preceding years had seen the
market accept a number of multi-billion
dollar sovereign debt restructurings in
Latin America under the Brady plan.
But the shock and severity of then-Fed
chairman Alan Greenspan’s monetary
tightening threw the emerging markets
into a crisis that snowballed over the
remainder of that decade.
Short-term rates rose from 3% at the
beginning of 1994 to 4.75% by midAugust. The benchmark Salomon Brady
Bond Index lost 33% of its value in the
first six months of that year, as investors
dumped the most liquid instruments
and fled emerging markets. They were

little enticed by bond sales from Latin
borrowers, which had recorded a fresh
high of $25 billion the previous year.
New issuance slumped to a few hundred
million per month.
Under Greenspan, the Fed would
continue hiking, until rates hit 6% in
February 1995.
Mexico, newly aligned with the US
through the North American Free Trade
Agreement (Nafta), suffered the most in
its so-called Tequila crisis. The country
required a $50 billion rescue package the
following year after its banking sector and
exchange rate collapsed.
Today, as investors parse Bernanke’s
words for clues to how soon and how fast
US rates will rise, the specter of 1994 still
haunts markets. In contrast to today, the
Fed back then only made a post-FOMC
announcement if it had altered rates, and
published its meeting minutes weeks later.
Société Générale expects US 10-year
yields could rise as high as 2.75% at the
end of 2013. That may have been an
aggressive call in early June when the
bonds yielded 2.18%, but less so two
weeks later when they had widened to
2.42%. UBS suggests 10-year yields will
hit 2.9% and could rise to 3.2% next year.
Guillermo Calvo, an economist at
Columbia University and co-author with
Carmen Reinhart of a seminal study on
the impact of US interest rates on capital
flows to Latin America, says that a sharp
rise in long-term Treasury yields could
prove destabilizing for Latin America’s
financial markets and economies.
“I’m worried about the increase in
long-term rates,” he says. “An increase in
those [10-year] rates is already tightening
up liquidity and that is how Latin
economies get hit – through the liquidity
channel.”
Calvo says that liquidity can rapidly
evaporate if inflows show a sharp
deceleration – a “sudden stop” – that
makes it difficult to sell assets. But unlike
in 1994, the trigger for a sudden stop is
more likely to be a rise in long-term rates.
“We won’t see a replay of 1994
because I don’t see the possibility of a
300 basis point increase in US short-term
rates,” he says. “I’m focusing instead on
the 10-year bonds and they are already
starting to go up.”
LatinFinance - July 2013

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