When Federal Reserve Chairman Alan Greenspan raised US interest rates by 50 basis points on May 16, traders marked down Latin American bonds, secondary market trading volumes slipped further still and the prospects for large scale debt issuance from the region vanished.


One week later, the JP Morgan EMBI index stood at 913 points, a level that pushed emerging market bond holders deeper under water and clouded prospects for any renewed vigor in the markets. By May 22, EMBI’s total return for this yea was 6.68% in the red, almost completely wiping out first quarter gains.

Emerging markets specialists said most borrowers from the region would remain sidelined until further rate increases had begun to allay inflation fears in the US. The slowdown worsened a frustrating second quarter for the Latin American markets.

As early as October 1999, pundits had started to proclaim 2000 as the year of the Latin America comeback. Recovering economies across the continent had already started to lure back investors into the asset class, including the all-important crossover investor base. High-grade bond buyers accounted for up to half of all emerging market bond buyers in the last quarter of the year.

Most were trying to get in on the end of a ‘quiet rally’- the EMBI index had tightened to 803 basis points at the end of 1999, from 1122 basis points at the beginning. That gave a total return of 21.56% to lucky, or prescient bondholders in for the ride from the start of the year.

Nowhere was the emerging market recovery stronger than in Latin America, a region still mired in crisis at the start of 1999. Propelled by the prospect of significant ratings upgrades across the region, a number of important landmarks were put in place for Latin borrowers. Argentina assumed its accustomed vanguard position in early January, with a Eu750 million bond – the largest bond yet in the young currency. Colombia and Venezuela also entered the euro markets – a sector the latter country was effectively ruled out of in 1999. And the swelling bid for Latin American paper also allowed Brazil to issue bonds out to 20 and 30 years – a maturity that would have been unthinkable in 1999. The region even played host to the first electronically sold bond when Argentina launched an offering sold at least partly over the Internet.

By mid-May, Latin America issuers had sold some $17.23 billion of international bonds, according to Capital Data. While that total was almost $2 billion short of the total for the same period last year, observers said that any slowdown was due to general market turbulence, rather than any shying away from Latin American credits as a class.

In truth, Latin American borrowers have had to labor throughout the first part of 2000 with markets affected by circumstances largely outside their control. The bond markets as a whole have been wracked by unprecedented volatility in swap spreads.

External Factors
The fate of Latin American borrowers has, however, been most closely tied up with that of two other asset classes – the US high yield market and the US stock markets. The link may be based on sentiment, rather than hard fact – the prosperity of key Latin American countries is much more closely tied in with the fate of the US economy as a whole, and so headline figures such as the inflation rate ought to be more closely watched than gyrations on Nasdaq.

But those external factors have continued to bedevil efforts to enter the dollar market. Latin borrowers have managed to get successful dollar bonds into the market – Argentina issued a highly sucessful $1.25 billion global bond in January, shortly after Brazil’s $1 billion offering. The Inter-American Development Bank launched a $2 billion global offering – its largest bond yet, and partly a reaction to the European markets’ increased focus on the euro. Borrowers in Argentina, Mexico and Brazil have issued yen-denominated paper, with Brazil’s BNDES development bank leading the way with a 30 billion yen bond in May.

But in retrospect, some of the warning signs of trouble ahead were already there early in the year. In the first week of January, Brazil was forced to put plans for its $1 billion 20-year bond on hold because of wild swings in the US stock and Treasury markets. US stock market volatility and high yield torpor look set to continue to thwart the attempts of Latin borrowers to enter debt markets throughout the rest of this year – particularly in the dollar sector.

The role of the dollar sector is changing, with big figures for Latin American borrowing masking some important shifts in the composition of flows from the region. Once largely dependent on the dollar as the chief conduit for international portfolio investment, Latin American sovereigns – and to a lesser extent supranationals, corporates and banks – have eagerly seized on the opportunities presented by the advent of the euro, as well as the more recent comeback of the yen bond market. The greenback accounted for 71% of all bond issuance from Latin America during 1998, a figure that dropped to 66% in 1999 and 61% so far this year.


Euro-Hungry Buyers
With European investors, particularly in Italy, eager to snap up the juicy coupons of over 10% on offer, the euro had almost become the funding route of choice for some of the leading Latin American sovereign issuers. Argentina had previously made full use of European currencies such as the deutschmark and lira, and the groundwork it put in really began to pay.

Italian investors have continued to buy in size during the first five months of 2000. Venezuela did not make it to market in either the dollar or the euro sector during 1999, but when the country launched a Eu500 million bond in March, Italian investors bought over half of the issue. Continuing appetite from key constituencies such as Italy provided the backbone for Argentina to re-enter the market in May with a Eu750 million bond, aimed at piercing the langor which had descended over the Latin new issue market. Led by Chase Manhattan and JP Morgan, the deal barely made it out the door and its travails showed how difficult a terrain the euro market had become in just a few months for Latin issuers and their advisors to negotiate.

The new Argentine debt team had made it clear earlier in the year that they were shifting their borrowing strategy in the euro – largely eschewing the more opportunistic, and sometimes technically driven program of frequent, smaller issues, in favor of fewer but larger deals in the single currency. The reasoning behind the move was not hard to fathom – to garner support from institutional investors which had already started to nibble at Latin deals during 1999, but which, above all, demanded benchmark bonds they could trade out of, even in volatile markets.

During 1999, European institutional investors had begun to play again in Latin American bonds as an asset class. A few US investors had even switched to buying Latin bonds in euro, rather than the dollar.

But wherever investors come from, liquidity is a key requirement. Argentina was not alone in focusing on generating liquidity in its debt program. The IADB’s $2 billion bond was twice the size of its normal offerings, in an explicit attempt to target liquidity conscious US institutional investors. Mexico’s early March Eu1 billion 10-year bond was also targeted at professional money managers, with the leads claiming to have hit the desired audience of crossover bond buyers before the country had regained its investment grade rating.

In mid-January, Brazil had already built on the work it put in last year in creating a creditable yield curve in the euro, by issuing a long awaited 10-year bond. The lead managers were able to place some 40% of the issue with institutional investors, but the European retail universe continued to provide the backstop bid.

When Argentina launched its Eu750 million, five-year bond in early May the size should have been enough to provide some chance of institutional support, and there was clear evidence of a weight of money building up for the right credit. But priced at 399 basis points over the benchmark, 25 basis points inside Argentina’s existing bonds, the issue went largely to traditional retail accounts, as high yield and crossover funds largely remained on strike.

Reflecting the malaise in emerging market debt, the Argentina bond has since traded out to nearly 470 basis points over Bunds. That performance has even begun to eat into the confidence of stalwarts such as the Italian buyer base. As with most other Latin American sovereigns, Argentina is likely to avoid the euro sector until sentiment picks up again. And with sovereigns finding the euro market tough going, as well as the dollar sector, the much touted arrival of Latin corporates in international bond markets is likely to slow to a trickle.

For sovereign borrowers from the region, the yen market has provided a safety valve but it is unlikely to meet more than marginal funding requirements. Argentina apart, Latin issuers have small financing requirements left to fill. With the dollar markets effectively closed and the euro markets in poor shape, that may be just as well.