Much of the market commentary peddled by emerging markets bond investors in 2021, as US Treasuries started to sell off during various periods of volatility, argued that “this time is different”. EM is in a far better place than when the taper tantrum battered economies and financial assets in 2013, they argued.
From a fundamental perspective, that is true. Moreover, despite the US Federal Reserve beginning to taper its bond-buying in November 2021, issuance has continued apace. Markets have endured more volatility, but never fully closed.
This does not mean, however, that LatAm bond markets will escape unscathed. Of the 10 questions in our survey, completed before the emergence of the Omicron variant, by 14 LatAm DCM heads, including eight of the top 10 bookrunners for 2021, the direction of spreads is the topic with by far the greatest consensus.
Only one banker believes LatAm dollar bond spreads over US Treasuries will end 2022 tighter than they begin the year, and only one thinks they will remain stable. Of the 12 that think spreads will end the year higher, one respondent even thinks they will widen by more than 20%.
“I don’t expect substantial widening in spreads, but given broader macro trends it’s hard to think LatAm spreads will tighten materially,” says Max Volkov, head of Latin America DCM at Bank of America. “Across the world, economies are recovering, and there is going to be less monetary stimulus in developed countries.
“US investment grade spreads are close to all-time tights and could start widening so LatAm might follow suit.”
Higher funding costs will also bring down the average maturity of new issues, reckon 64% of bankers quizzed. As one banker puts it, the days of the 50 year bonds that were all the rage in January 2021 are over.Until September 2021, Latin American bond issuers had for almost a year had the luxury of picking virtually whichever day they wanted to tap markets. With only a few exceptions, pretty much every day was “a go day”, in syndicate parlance.
Politics gets in your eyes
Volkov reckons that interest rate volatility will lead to “far more limited windows of issuance than what we had enjoyed until September this year”.
Indeed, when asked which factor would be most likely to complicate market access for Latin American and Caribbean issuers in 2022, a majority of DCM heads ticked “US monetary policy”. They had yet to hear about Omicron.
Several survey participants were unable to pinpoint one sole factor, and selected both US monetary policy and Latin American domestic politics. There is a reasoning behind this indecisiveness: it is the combination of both factors that could be critical for LatAm debt markets.
“My biggest concern about 2022 is if tapering in developed markets is combined with weaker economies, mixed with an unstable political cycle in Latin America,” says Lisandro Miguens, head of Latin America DCM at JP Morgan.
“The political outlook has been tricky for some time in much of the region, but will become a far more critical issue for bond markets as global monetary policy is tightened.”
Indeed, concerns about policymaking in Latin America have already been increasing in recent years — even in previous safe bets like Chile, Peru and Mexico.
Gordon Kingsley, Crédit Agricole’s head of LatAm DCM, notes that huge fiscal and monetary stimulus from developed economies has “blanketed” much of the political and macroeconomic noise in Latin America.
“As that stimulus fades, domestic issues will come more sharply into focus for investors,” says Kingsley. “Though I don’t expect to see a significant widening in spreads, investors will be able to be a bit pickier about what they’re buying.”
2022 will begin with eyes on the policy direction taken by Chile’s new government, elected in late 2021, before they turn to presidential elections in Colombia in May. Then comes Brazil’s general election, scheduled for October, which is likely to disrupt the rhythm of new issues.
“I expect Brazil to be very busy in the first half of the year, because election volatility will make the second half more difficult,” says Kingsley. “Some of the higher yielding names, especially, will want to lock in low-cost funds while they can.”
Volumes to drop
Even if the first half of the year is particularly busy in Brazil, the fact that most expect new issuance to stop in the run-up to the election means that overall volumes will likely be down.
Volkov at Bank of America highlights a second reason to be pessimistic about Brazilian volumes: interest rates. Brazil’s Selic rate has increased from 2% in March to 7.75% in November, and is expected to continue to rise.
“This means a lot of funds in Brazil are rotating out of equities and back into credit,” says Volkov.
Liquidity in the domestic bond market is therefore high, and several firms in Brazil that could have raised capital in dollars are likely to turn to the domestic markets instead, says Volkov.
“There are also longer maturities and greater sizes available in the local debentures market than ever before,” he adds. “Even with higher local rates, it is cheaper for companies to issue locally than to print in dollars and swap back into reals.
“Add in that in election years, we have seen Brazilian cross-border issuance typically slow as volatility rises.”
All this chimes with the majority view — held by nine of the 14 bankers asked — that Latin American and Caribbean cross-border bond volumes will be lower in 2022 than in 2021. Just three bankers expect volumes to increase, and there’s just one optimistic outlier predicting that volumes will increase by more than 20%.
Yet Brazil is not the main driver of expectations for lower volumes.
BNP Paribas’ head of Latin America DCM, Andre Silva, also predicts a “tougher environment” for LatAm bond markets, noting that elections are a reason to expect more domestic volatility and that external conditions will lead to higher funding costs.
“A third important consideration for volumes is that a lot of this year’s issuance has been due to the pandemic driving greater fiscal spending,” says Silva. “I do not expect that to be replicated to the same extent. It will still be a reasonably active year, but I’d expect overall volumes to be down.”
Chile has been by far the most active Latin America sovereign borrower in international markets during the pandemic, selling over $15.3bn-equivalent in hard currency bonds in 2021 — almost 12% of the total printed by LatAm and Caribbean issuers of all types as of mid-November. This is up from around $5.9bn in 2020 and just $2.4bn in 2019.
Peru, for so long a rare sight in external markets, has also relied heavy on dollar and euro funding in 2021, accounting for over $10bn equivalent of supply.
Miguens at JP Morgan shares the view that lower sovereign issuance will lead to lower bond volumes overall. But some of this will be offset by “robust” M&A activity, he reckons, leading to growth in corporate issuance. Five of the 14 bankers believe LatAm corporate issuance will increase in 2022.
ESG — is EM different? |
ESG bond activity really took off in Latin America in 2021. While green bond issuance had already been rising, the advent of sustainability-linked bonds opened the door for a far greater range of LatAm companies to market ESG-themed deals. Yet bankers say that investors are also applying far greater scrutiny to issuers — both when examining the key performance indicators used in an SLB, and when evaluating their broader ESG credentials. While protein producer JBS’s sustainability-linked bond issue in June perhaps predictably found opposition from environmental activists given its links to deforestation, several mainstream EM investors have told GlobalCapital that they’ve turned down SLBs or green bonds from LatAm borrowers because the businesses themselves do not meet certain ESG standards. “For either SLBs or use-of-proceeds bonds, we expect investors to consider issuers’ overall ESG policies before buying,” says Gordon Kingsley at Crédit Agricole. GlobalCapital therefore asked DCM heads whether “substantially more funds” will refuse to buy bonds from fossil fuel producers or other polluting sectors. The question splits opinion. While over 40% of bankers take the diplomatic route of saying the issue is “not cut and dried”, some 28.5% argue this is “very likely”. But the same proportion say this will not happen, because “EM is different”. “Generally, funds are not refusing to buy bonds on ESG grounds, but they are certainly becoming more choosy and demanding,” says Kingsley. “Most investors see ESG in emerging markets in a slightly different context, largely because of the nature of the economies.” Indeed, Latin America is largely a natural resources-based region, where sectors like energy and the extractive industries are often the mainstay of the economy. “Investors don’t want to run away from these companies, and would rather engage to try to have some influence on the issues than simply decline to invest,” says Kingsley. There’s another concern for EM portfolio managers: fossil fuel producers such as Pemex and Petrobras are flagship issuers of the asset class. Another LatAm DCM head reckons that investors understand that major state-owned companies in EM, for example, can’t move as swiftly as private companies in the G7. “However, this will start to happen over the next five years,” he says. “Major fund managers are quite forcefully telling fossil fuel producers that there will be a time where they can no longer invest as before unless they make changes.” Kingsley believes that some investors may start to prefer the more traditional use-of-proceeds bonds over SLBs again, given this format gives their investment a clearer ESG link. Yet bankers still expect deals with KPIs to rule. Nine of the 14 DCM heads predict that there wil be more SLBs than use-of-proceeds bonds, highlighting that it is easier for smaller corporate issuers, especially, to draw up a sustainability performance target than find sufficient eligible use of proceeds. GC |