Over the past two weeks, investors have reacted favourably to the latest US initiatives to jumpstart capital markets. But analysts say plummeting regional growth and the ongoing disruption in G7 markets may further erode Latin asset prices.
The MSCI stock market index for Latin America dropped 2.65% on Friday, capping gains for the week at 3%. Nevertheless, regional equities have gained 14% over the past month.
Latin America has been emboldened on the face of it, by the tentative shifts in global risk perceptions, said Paul Bisko, senior emerging markets analyst at RBC Capital Markets. However, this sharp rally in tandem with global stock markets raises the risk that prices may fall as investors rush to take profits.
Despite the improvement in global risk appetite, the Mexican peso weakened 1%, the Brazilian real 0.4% and Colombia peso 3% to the dollar this week. Emerging sovereign bond spreads in JP Morgans EMBI index tightened to 620 basis points (bp) a 2009 low with Latin spreads compressing by 15 bp.
However, this modest compression in bonds indicates investor aversion towards emerging market assets while Latin America is being dragged by negative economic prospects, Bisko said.
He argued market technicals, rather than strengthened appetite for credit risk, have allowed bond spreads to tighten. He cited declining redemption requests from emerging market debt funds and a modest reduction in short exposure to Latin fixed-income securities into longer-dated risk.
Blaise Antin, head of research for the $1.9 billion TCW Emerging Market Fixed Income Fund in Los Angeles, fears markets may have prematurely priced in a successful resolution of the US banking crisis.
People have probably got way ahead of themselves this week. We have to be concerned about what is happening to the real economy in the US.
The weakness of regional currencies, low oil prices and the prospect of a regional recession will detain Latin America in bear market territory unless a massive upswing in G7 markets is achieved at the forthcoming G20 summit in London, analysts said.
Nevertheless, Latin Americas lower leverage and stronger liquidity position than other emerging regions, combined with the positive effects of monetary easing and international efforts to boost dollar liquidity, will soften the blow of slowing growth.