• York Investment & Finance

Global Markets Overview: Latin America

By Tom Ives, Analyst at the York IFS Global Market Telegraph

Latin American markets slump further as spike in bond yields reinvigorates ‘Taper Tantrum’ fears. Tensions escalate in Brazil following President Bolsonaro’s decision to fire Petrobras CEO Castello Branco.

A rout in global bond markets and growing fears surrounding President Bolsonaro have subdued broader sentiment as investors move away from Latin American assets. The MSCI Latin America EM index has continued its descent after a backlog of bad publicity in Brazil deterred investment from abroad. Regional currencies were also hurt by a stronger dollar but pared initial losses, tracking strength in crude prices.

Despite further resurgences of coronavirus cases across the region, optimism was beginning to return to Latin America. Many funds, including the wealth management arm at UBS, had forecasted a strong year for Latin American markets in 2021. They cited fast growing commodity prices and more certainty around US trade policy as the major catalysts.[1] However, even with the promise of a potential commodity ‘supercycle’, Latin American markets have lagged behind their emerging market peers for some time now. Government debt remains one of the longstanding obstacles for an economic recovery in Latin America, with many nations now trapped in a vicious cycle where they cannot grow fast enough to stabilise these high debt levels.

Concerns over rising bond yields persist as higher yields place increasing pressures on LatAm economies which are already struggling to mount a recovery from the virus. Regional debt and equity markets have already experienced large bouts of volatility in recent times as Latin American markets are beginning to feel the full force of the spike in US treasury yields. The rise in long term rates can be attributed to changing inflation expectations, with 10-year US Treasury yields now reaching 1.56% nearing pre-pandemic highs.[2] It can be argued that current conditions are reminiscent of the ‘taper tantrum’ in 2013: a mass sell-off in emerging market assets following a sudden spike in US Treasury yields, invoking a fearful reaction in the markets. The silver lining is the current yield for ‘real’ US Treasuries. Real yields driven down by Fed policies currently sit at negative 80 basis points, which can perhaps alleviate concerns that another ‘taper tantrum’ of the same size is on the cards.

If the Fed does increase interest rates, the impacts on emerging markets will probably be severe. Most likely, Latin American nations will have to respond with similar measures to stabilise their currencies. This comes at a pivotal time where funding is especially important when extensive stimulus measures have been employed by Latin American economies. Whilst its use borders on essentials given the economic fallout from the pandemic, the use of these strategies is a double-edged sword. During 2020, a weak dollar and the prevalence of low interest rates meant emerging markets had access to relatively cheap credit. The resulting increase on government borrowing will likely cut into future economic growth, especially when debt issuance is a pivotal source of revenue for LatAm governments.

Labelled as ‘Trump of the Tropics’, populist president Jair Bolsonaro has always been a controversial figure. However, his latest decision to fire CEO Roberto Castello Branco of state-owned oil firm Petrobras has sparked widespread protests in Brazil. The President was also heavily criticized over his nomination in General Joaquim Silva e Luna as a replacement. Given that Luna has no experience in the oil industry and served under the Brazilian military dictatorship that spanned over two decades in Brazil until the late 80s, it is understandable that his character has come under scrutiny. The decision has left current investors on edge as worries persist over political interference into other sectors in Brazil. If the board further progresses with their plans to install Luna, it could have devastating consequences on its citizens' welfare as well as on the Brazilian economy.

The market reacted to the news in a similar fashion, as the decision prompted a mass sell-off in Petrobras. Shares had initially risen once the firm announced that they were raising both oil and diesel prices following strength in international crude prices. However, the subsequent departure of Castello Branco soon wiped out gains and the sell-off erased US$19 billion in market value for Monday alone.[3]

It is believed the deposed CEO and President Bolsonaro clashed over the price set for crude oil exports. Bolsonaro was reportedly unhappy with the decision to raise national prices in tandem with higher global crude prices. Whilst the decision has raised eyebrows in Brazil, it could be argued that there is some logic behind his decision. Oil remains a key source of revenue for most Latin American nations, most notably Brazil. Cheap prices remain one of the most attractive features of Brazilian crude, as Brazil tries to prize market share away from the longstanding dominance of OPEC. The global pandemic has suppressed international crude prices for the best part of a year, as lockdown protocols placed restrictions on economic activities worldwide. However, since late November, Brent crude prices have been steadily rising on optimism surrounding a global recovery, with prices now reaching just under US$68 a barrel.[4] It is particularly important that Petrobras set prices at an optimal price given the current speculation surrounding the commodity. JP Morgan and Goldman Sachs have been one of many to predict a ‘supercycle’ for oil. Whilst there has been no consensus on whether this will actually materialize, this could be a pivotal factor in rejuvenating the Brazilian economy after years of sluggish growth.

This article was first published in the University of York Investment and Finance Society's Global Market Telegraph (GMT) Edition 16 in early March 2021.

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Reference list:

[1] https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/latam-could-outperform-other-emerging-markets-heading-into-2021-ubs-says-61312517 [2] https://www.bloomberg.com/markets/rates-bonds/government-bonds/us [3] https://www1.folha.uol.com.br/internacional/en/business/2021/02/petrobras-loses-us-19-billion-in-market-value-after-bolsonaro-intervention.shtml [4] https://www.proactiveinvestors.co.uk/companies/news/943132/crude-prices-hold-firm-as-opec-and-friends-opt-against-production-rise-943132.html


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