Asset managers are increasingly drawn to Latin American bonds and currencies due to the region’s high interest rates, low inflation, and more resilient economies than anticipated. Latin America is home to five of the top eight performing currencies this year, benefitting from the proactive actions of regional central banks, which raised and maintained interest rates despite receding inflation. Local bond returns have also outperformed those of developed markets, attracting investors with substantial inflation-adjusted yields.
Paul Greer, an emerging markets debt and FX portfolio manager at Fidelity, highlighted the growing appeal of Latin American currencies due to the increasing real yields. Greer’s portfolio is overweight in local currency bonds from countries such as Brazil, Mexico, Colombia, Peru, and Uruguay, as he believes Latin America is “the place to be” for both government debt and currency exposure. However, Greer mentioned that Argentina is an exception, as the country has been cut off from international markets following a debt default and struggles with high inflation.
Latin American central banks took swift and decisive action to address inflationary pressures following the coronavirus pandemic, leading to a faster containment of price growth compared to other regions. The high interest rates implemented by these central banks did not hinder economic growth. Brazil and Mexico, the two largest economies in the region and popular among international investors, exceeded growth forecasts in the first quarter of this year, prompting economists to revise their projections for the year-end.
The decline in annual inflation in Brazil, from over 13% to below 4%, and the maintenance of high interest rates at 13.75% since August 2022, along with Mexico’s steady rates at 11.25% and a drop in headline inflation to 6% in May, make the currencies of these countries attractive investment options. Iain Stealey, Chief Investment Officer of Global Fixed Income at JPMorgan Asset Management, highlighted the compelling argument for adding these currencies to portfolios due to their real yields.
Market concerns over left-wing governments in Brazil, Chile, Colombia, and Peru have subsided, as their lack of congressional majorities limits their ability to implement certain policies. Moreover, the independence of central banks has been maintained, despite calls from politicians such as President Luiz Inácio Lula da Silva in Brazil and President Andrés Manuel López Obrador in Mexico to cut interest rates.
Geoffrey Yu, Senior Foreign Exchange Strategist at BNY Mellon, credited years of foreign investors avoiding the region as another reason for the success of Latin American currencies and bonds in 2023. The lack of positioning makes it an opportune time to buy bonds before central banks begin cutting rates.
Concerns arise over the sustainability of the rally as central banks in the region consider rate cuts ahead of other regions. Chile is expected to commence rate cuts this month, followed by Peru and Brazil in August, and Colombia and Mexico by the end of the year. Despite this, if central banks proceed with gradual rate cuts, the currencies across the region could continue to perform well. Mexico, in particular, possesses long-term structural advantages as it benefits from the relocation of US companies from China and a surge in remittances, albeit with sensitivity to the US economy’s pace.
While risks remain, emerging and developing markets, including Latin America, are perceived to be better positioned than their developed market counterparts. Investors such as Jim Cielinski, Global Head of Fixed Income at Janus Henderson, anticipate higher levels for the Mexican peso and Brazilian real by the end of the year, highlighting the potential for sustained performance as inflation recedes and the possibility of rate cuts arises.
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