Divergence between Latin America and the Fed favors local bonds | ECONOMY

The depressed local bonds of Latin America are once again the focus of investors, who see an opportunity to benefit from monetary policies that are not in step with those of the developed world.

Some of the region’s central banks have raised interest rates so aggressively over the past year that they may start easing borrowing costs as early as the end of this year, after inflation peaks. This would occur as the Federal Reserve begins its own tightening cycle.

The lag — Latin America ends up cutting rates while the Fed raises them — is creating conditions that favor local bonds over the next 12 to 18 months, according to Eddy Sternberg, co-manager of emerging-markets debt at Loomis Sayles in Boston. Assuming growth will continue at a moderate pace and inflation will decline, he estimates that domestic bond prices will rise as interest rates fall.

“The high prices of raw materials are favorable for the external accounts of most South American economies, since they keep currencies under controlsaid Sternberg, whose firm manages $363 billion in assets. “So central banks will have room to cut late this year or early next, and doing so cautiously should be positive for local curves.”.

Latin American local-currency bonds are already outperforming this year, yielding more than 5%, according to a Bloomberg index, while the region’s dollar bonds are down more than 6%. US Treasuries have lost 3.2% in the same period.

Of course, the ability of local central banks to cut rates depends on how quickly inflation comes down, according to Cathy Hepworth, a portfolio manager at PGIM Fixed Income in Newark. That picture has become much darker after the Russian invasion of Ukraine sent oil prices above $110 a barrel and caused prices of food staples like wheat to rise, further hurting farmers. Latin American consumers.

“Does the Fed hike prolong the rate hike cycle of these central banks? Not necessarily”, Hepworth said. “What matters most in those countries is where the inflation is and to what extent the inflation starts to reverse.”.

The origin of the divergence of central banks is related to inflation, which accelerated in Latin America at a faster rate from mid-2020 than in developed countries. That prompted aggressive responses from the region’s monetary policymakers.

Since the beginning of 2021, Brazil has increased rates by 8.75 percentage points, while Chile and Colombia have raised them by 5 and 2.25 percentage points, respectively.

In the same period, the upper band of the Fed’s reference rate remained unchanged at 0.25%. Central bank Chairman Jerome Powell backed a quarter-point rate hike this month, though the extent to which the Fed will raise interest rates this year remains uncertain. Even with US inflation at a 40-year high, Fed governors have only timidly moved to tighten policy.

Faced with the prospect of inflation nearing its peak in Latin American countries, central banks have slowed the pace of rate hikes.

Of course, risks continue to abound in Latin America. From the political turmoil linked to the presidential elections in Colombia and Brazil this year to the possibility of a further spike in consumer prices due to the war in Ukraine and disruptions in commodity markets.

But the frenzy of rate hikes in the region should cool growth and consumption, even as export earnings rise, and that will moderate inflation, provide more support for currencies and make it easier for policymakers to reduce the costs of borrowing, according to Aaron Gifford, emerging-market sovereign debt analyst at T. Rowe Price Group in Baltimore.

“A year from now, countries like Chile and Brazil, which aggressively hiked rates, could find room to start cutting them while the Fed keeps raising them.Gifford said. “Moderate growth prospects, normalization of inflation and recovering currencies will help these countries stay on their feet despite what happens with Fed policy”.

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