High Rates in Latin America Attract Bond Investors

Higher interest rates in Latin America are luring bond investors.

Rio de Janeiro, Brazil
Andrew Holt | Photographer's Choice RF | Getty Images
Rio de Janeiro, Brazil

“Investors are getting higher yields on their emerging market bond positions than their US bond positions,” says Brad Durham, managing director of EPFR Global, a fund tracking firm that follows $15 trillion in total assets globally.

“If they are Brazilian real or Colombian peso or whatever, most of those currencies have been appreciating against the dollar, so they get an extra kicker from that appreciation.”

Central banks hiking interest rates to deal with inflationary pressures in those countries boosts local currency appreciation even more, he says.

Flows into Latin American bonds had been tepid for the last six to 12 months, says Durham, but since March 23 the asset class has strengthened by $1.4 billion. Year to date, Latin American bond inflows are $2.3 billion.

“There was concern in the fourth quarter of last year about inflation and whether central banks were reining in inflation,” he says. “Looks like they finally caught up with the game.”

Earlier this week, bond king Bill Gross of PIMCO wrote in his newsletterthat he favored non-dollar-denominated emerging-market debt, pointing out that low interest rates in the United States and inflation pose "an immediate threat" to investment portfolios.

As US bonds lose favor with some bond fund managers like Gross, local currency bonds in Latin America could attract even more investor attention.

“Emerging-market balance sheets are much cleaner and they have improved significantly over the last decade,” says Lupin Rahman, a fund manager and credit analyst who works with Gross. “Their sovereign creditworthiness has improved tremendously.”

The International Monetary Fund forecasts emerging economies will grow nearly three times as fast as developed nations in 2011. Driven by abundant global liquidity and high commodity prices, Latin American economies are expected to expand 4.7 percent this year.

While developed nations owe about the equivalent of one year of their economic output in gross government debt, Latin America owes half that, says the IMF.

Countries in Latin America have already learned lessons from their own debt crises in the 1980s, says Rahman. Just as the Fed continues easy monetary policy in the US, countries in Latin America have already cut deficits, borrowed in their own currencies and reined in inflation.

Brazil's central bank, for instance, has raised the benchmark rate three times this year to 12 percent.

Meanwhile, Standard & Poor's downgrade on the US economic outlook last month benefited Mexican and Brazilian bonds. While the risk aversion to a sovereign rating shift was small for US dollar-denominated debt, says Rahman, local government bonds in Latin America rallied.

“What that points to is, A) the market had already priced in some negative action from the rating agencies, and B) the market is now viewing emerging-market debt as relatively safer than some of the more advanced economies.”

Although the Brazilian real lost some ground this week, the currency has gained some 40 percent against the dollar over the past two years.

“It really takes more than one or two days to derail this medium-term story, which is extremely positive,” she says. “In Brazil you’ve seen a very strong fiscal consolidation this year, and that’s going to be relatively constructive for local markets.”