NEW YORK, Aug 14 (IFR) - LatAm bonds were off recent wides on Friday after a rough and tumble week for the region following China’s surprise devaluation of its currency.
Still, a cautious mood prevails among buyside accounts following another week of outflows for the asset class and expectations of a US rate hike in September.
“The China concerns have calmed down a bit and the market has stabilized, but it is still cautious,” said a New York based trader. “We have put a cap on spread widening for the time being.”
Brazil’s five-year CDS was back at 305bp on Friday morning after gapping out to 325bp earlier this week, while the sovereign’s 2025s were being quoted at 94.35, up from the 92.25 level seen earlier in the week.
China’s decision to loosen the renminbi peg this week may have unnerved markets fretting about the fragility of Latin American fundamentals, but investors see few immediate threats from the Asian nation’s shift in FX policy.
“We don’t expect a radical effect on the economic dynamics of the region,” said Alejo Czerwonko, an economist in the chief investment office of UBS Wealth Management.
Chinese authorities are widely expected to take baby steps to liberalize the exchange rate in an effort to gain reserve currency status rather than undergo dramatic devaluations to bolster growth.
“We will wait for any future signals, but the market doesn’t seem to believe we will see significant depreciation pressures,” said Kevin Daly, a portfolio manager on Aberdeen’s EM fixed-income team.
Still, China’s decision to weaken its currency has increased trepidation about the overall strength of an economy that has in recent years been a big driver of growth for commodity exporters in Latin America.
“Our worry is that they might be revealing to the investor community that economic activity is not as good as what the market is pricing in,” said Czerwonko.
Indeed, uncertainty about Chinese economic policies has only exacerbated concerns about weakening fundamentals in Latin America, which is already suffering from the impact of a commodity slump and weakening local currencies.
This has been reflected in the poor performance of JP Morgan’s EMBI Global’s Latin American component, which has only eked out a 0.82% return year-to-date.
That compares to the 3.22% seen over the same period for JP Morgan’s EMBI Global Index, ex Latin America.
Latin American countries that have been particularly vulnerable to events in China include Chile, Peru and Brazil, whose sales to the Asian country as a percentage of total exports stand at 24%, 18% and 18%, respectively, according to UBS.
Like Brazil, Chile has seen spreads on five-year CDS gap about out to 110bp, up from 77bp seen in mid June. It is similar story for Peru, where five-year protection is now being quoted at 154bp versus the 131bp seen on July 21.
Yet while those trade figures are higher than the 10% average for EM countries overall, such economies remain relatively closed and hence are less exposed to any changes in the terms of trade, said Czerwonko.
Czerwonko measures trade openness by looking at exports and imports divided by GDP. In the case of Brazil, Chile and Peru, that ratio is relatively low at 21%, 56% and 41% compared with more open economies such as Malaysia at 132%, Taiwan 116% and Thailand 119%. (Reporting By Paul Kilby; editing by Shankar Ramakrishnan)