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Rate and commodity shifts threaten sovereign complacency 0

Jun 20, 2013

Signs that the US Fed will seeks to begin tapering off stimulus have led to selloffs for EM assets, and concerns that the days of cheap borrowing may be over. If the end of cheap debt is combined with commodity prices coming off historical highs, some LatAm governments could be caught in the pinch. The restructuring spotlight has firmly been on Europe in recent years, though it threatens to shift back to EM, including LatAm.

"The strains on EM will begin to appear in the next two years," said Lee Buchheit, partner at Cleary Gottlieb Steen & Hamilton, and veteran of multiple sovereign restructurings. "They have been plastered over by these benign macroeconomic phenomena. The dearth of restructuring over the last five years in emerging markets generally has been a happy product of historically low interest rates and historically high commodity prices. When you get those two things moving in the right direction it provides relief for countries that otherwise might have been the object of concern."

The lawyer cautions that it is still too early to start making predictions as to who will struggle, particularly among the region's larger economies. However, the Caribbean nations have not benefitted as much from the pair of favorable trends.

"The debt situation for many of these countries remains very fragile," Buchheit said, pointing to the recent developments in Belize, Grenada and Jamaica.  

Jamaica followed up the $7.7 billion JDX exchange in 2010 with the $9.1 billion NDX this year, and still faces challenging funding needs. Grenada has missed coupon payments and is seeking an agreement with creditors. Belize completed a debt exchange in March.  

Could some of the larger LatAm countries be in trouble? It is possible, the veteran lawyer said.

"If you have a significant drop in commodity prices and a significant rise in interest rates, it would begin to show some of the strains on those economies," Buchheit said. "Generally, there is no doubt that EM countries have inoculated themselves from some of these difficulties, having gone through the horror of the 1980s and for some of them further restructurings in this century."

With several countries receiving strings of upgrades in recent years, it would appear that many are confronting the more challenging times from a strong position. Brazil, however, was assigned a negative outlook by S&P earlier this month, as a combination of weak growth and fiscal deterioration threaten its government’s position.

The US Federal Reserve said Wednesday it may phase out monetary stimulus, sending US and LatAm equity indexes falling Wednesday and again Thursday. The Fed’s tone had many preparing for a shift in rates and volatility ahead.

"Chairman Bernanke appears to have validated expectations that the era of ultra-low interest rates is about to end. An implicit floor in US rates will put pressure on and add volatility to long-term rates in LatAm," Bank of America Merrill Lynch said in a report. The shop expects currencies and interest rates in Latin America to trade with a bearish bias – weaker currencies, higher and steeper curves – and high volatility in the near term.LF



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