Latin American Bonds Rally as Inflation Falls Below U.S. Levels
By Valerie Rota and Adriana Brasileiro
Oct. 2 (Bloomberg) -- Latin American bonds are posting their biggest gains in more than a year as inflation in Mexico and Brazil, which topped 6,800 percent in April 1990, falls below U.S. levels.
Dollar-denominated debt issued by Latin American governments returned 7 percent in the third quarter, the most since the second quarter of 2005, according to data compiled by Merrill Lynch & Co. The gain is almost double the 3.65 percent return on Treasuries during the same period, Merrill data show. Investors say the gains will continue for the rest of the year.
Brazil's annual inflation rate fell to 3.7 percent in the 12 months through mid-September, down from its record of 6,821 percent. Consumer price increases in Mexico, which surpassed 170 percent in 1988, were 3.5 percent in August. It is the first time both countries have lower inflation rates than the U.S., where consumer prices rose 3.8 percent in August, according to International Monetary Fund data.
``The phenomenon of inflation is not the boogeyman it used to be,'' said Luiz Fernando Figueiredo, a former Brazilian central bank monetary policy director who now is a partner at Maua Investimentos, a Sao Paulo-based hedge fund. ``When you know inflation will be under control and you can trust inflation forecasts, you know the value of your investment won't be eroded.''
The average yield on Brazilian dollar-denominated bonds has dropped to 7.03 percent, or 2.3 percentage points above similar- maturity U.S. debt, from 7.99 percent on May 24, according to an index compiled by JPMorgan Chase & Co. The yield gap, or spread, was more than 8 percentage points in May 2004.
Bond Auctions
The spread may fall another percentage point over the next year, said James Barrineau, who helps manage $9 billion in emerging-market bonds at Alliance Bernstein in New York.
Barrineau said the yield spread on Mexican dollar bonds may fall as much as 30 basis points, or 0.3 percentage point, in the next 12 months to 0.9 percentage point. The spread was 11.6 percentage points in 1998.
Bonds denominated in Mexican pesos and Brazilian reais also are rallying. Mexico's benchmark seven-year peso-denominated bonds have returned 10 percent in the past 12 months, including reinvested interest.
Mexico tomorrow plans to sell 3 billion pesos ($273 million) of seven-year debt. The yield likely will fall to 8.19 percent from 8.54 percent a year ago, saving the government about $956,000 million in annual interest costs. The government didn't begin selling fixed-rate debt with maturities of more than year until 2000. When it sold one-month bills in 1988, it paid an annual interest of 158 percent.
Taming Inflation
The yield on Brazil's fixed-rate local-currency bond due in April 2008 will probably fall below 14 percent at a government debt auction scheduled for Oct. 5 from 17 percent a year ago. The government plans to sell 2.5 billion reais ($1.1 billion) of the bonds. The decline in yields will save the government about $34 million in annual interest.
Latin American governments tamed inflation by making central banks more independent and reducing spending, said Alberto Ramos, a senior Latin American economist at Goldman Sachs Group Inc. in New York. Inflation in Latin America in the 1980s and 1990s was spurred by central banks printing money to offset shortfalls in government revenue.
``Governments learned their lesson,'' Ramos said in a phone interview. ``They can't live beyond their means forever without causing inflation.''
Surging prices on commodities that the region exports, such as oil, copper and gold, also slowed inflation by sparking currency rallies that cut the cost of imports.
Investment Grade
In Mexico, the decline in inflation and narrowing of a budget deficit under President Vicente Fox helped the country win an investment grade credit rating in 2002. Standard & Poor's now rates Mexico BBB.
Brazilian President Luiz Inacio Lula da Silva cut the inflation rate to a seven-year low and took advantage of rising export commodity revenue to pay foreign debt, helping build support for his re-election bid. With 80 percent of ballots counted, Lula had taken 49.6 percent of the presidential vote. He needs one vote more than 50 percent to win in the first round and avoid a runoff in three weeks.
On Aug. 31, Moody's Investors Service raised the government's foreign-currency bond rating to Ba2.
Bonds rated below Baa3 by Moody's and BBB- by S&P are considered below investment grade.
Brazil's central bank last week cut its yearend inflation estimate to 3.4 percent from 3.8 percent. That is under the government's target of 4.5 percent.
Vietnam War
Mexican and Brazilian inflation rates have never been below the U.S. rate at the same time. Mexican inflation was less than in the U.S. in early 1971, when President Richard Nixon was funding the Vietnam War. In early 1999, Brazil's annual rate fell to 1.65 percent, under the U.S. rate, after the central bank raised the benchmark lending rate to more than 40 percent to stem an outflow of capital and devaluation.
``It is very unusual,'' said Barry Eichengreen, a professor of economics and political science at the University of California at Berkeley who has written several books on the history of monetary policy and inflation. He said the Mexican and Brazilian currencies would have to keep gaining against the dollar to keep inflation in those countries below the U.S. rate.
Brazil's real has risen 47 percent against the dollar since May 2004. Mexico's peso is up 4.3 percent over that time.
Venezuela, Argentina
Chile and Peru have implemented similar policies aimed at curbing inflation. Chile had annual inflation of 3.8 percent in August, down from 37 percent in 1985. Peru's inflation was 1.9 percent in August, down from 6,900 percent in 1991.
Venezuela and Argentina have lagged other countries in the region. Venezuela's annual rate was 14.9 percent in August, the highest among the 10 biggest Latin American economies, after President Hugo Chavez boosted spending by 80 percent in the first half of this year.
Consumer prices rose 11 percent in Argentina in the 12 months through August as government spending fuelled demand. President Nestor Kirchner implemented price controls on some goods last year in a bid to bring inflation below 10 percent.
``These countries are outliers,'' Alliance Bernstein's Barrineau said. ``The economic policy choices they have made aren't the best.''
Mexican central bank Governor Guillermo Ortiz and Brazilian central bank President Henrique Meirelles have played key roles in bringing down inflation, Barrineau said.
Ortiz ``has done a superb job,'' Barrineau said. He said Meirelles has helped Brazil gain the confidence of investors.
``This year, when you look at the rapid decline in inflation expectations in Brazil, you see that the central bank has really consolidated its credibility,'' Barrineau said.
To contact the reporters on this story: Valerie Rota in Mexico City at vrota1@bloomberg.net ; Adriana Brasileiro in Rio de Janeiro at abrasileiro@bloomberg.net
Last Updated: October 1, 2006 21:02 EDT |
