Move over, bitcoin: El Salvador sovereign bonds not done rallying

Investors in El Salvador international bonds are relishing 60 per cent returns this year alone as debt issued by the Central American country recovers from calls of doom and default, with some betting the rally is not quite over yet.

Rising tensions between Washington and President Nayib Bukele’s government, dwindling prospects of a financing deal with the International Monetary Fund (IMF) and the fallout from bitcoin becoming legal tender against a wider difficult macro backdrop had seen El Salvador bonds drop to a quarter of face value last July.

Fast forward 12 months and two surprise debt buybacks have left the country’s payment schedule very light until 2027, while the appointment of a former IMF official as adviser to the finance ministry has sent the right signals to markets, investors say. A bond maturing in 2025 is trading at 89 cents, up from about 27 cents a year ago.

“In the summer of 2022, El Salvador bond prices were divorced from fundamentals,” said Aaron Stern, managing partner and chief investment officer at Converium Capital in Toronto, who has been holding the country’s bonds since last year.

“The market was concerned about the administration’s willingness to pay,” he said, but even now El Salvador offers attractive value when compared to a number of better priced emerging market sovereigns.

The appointment of ex-IMF official Alejandro Werner resuscitated hopes that an IMF deal might eventually come good – and in the meantime, the country could see more structured policy making.

“Bukele has one of the highest approval rates and he has managed that successfully, and there’s also an understanding that you have to make sure that the country continues to have access to the market… it’s a dollarized economy,” said Shamaila Khan, head of fixed income for Emerging Markets and Asia Pacific, UBS Asset Management.

El Salvador’s debt-to-output ratio stood at 77 per cent in December, the lowest since 2019, and is forecast to drop another percentage point this year before rising to 78 per cent in 2024, according to Refinitiv data. Total public debt was $19.7 billion in May from $25.4 billion at the close of 2022.

Salvadoran dollar bonds currently yield between 14 per cent and 18 per cent, according to Refinitiv data. These were the best performing among sovereign bonds in the first half of the year, with total returns near 60 per cent. And even after such a run, some say it’s not yet time to cash out.

“In a year where carry is the main driver of total returns, investors are going to be reticent to take profits too early,” said BNP Paribas’ Nathalie Marshik, a managing director for Latin America fixed income.

“El Salvador is somewhat uniquely positioned as one of the highest yielding ‘performing’ distressed credits,” she said, adding that it would take a “significant” fiscal deterioration or a change in the political tone towards the market for bonds to stage another selloff.

JPMorgan moved its recommendation on the country’s hard-currency debt to “overweight” from “market weight”, saying “the external and fiscal picture of the country seem constructive in the short term”.

Some wonder how much more road the story has to run, with February presidential elections raising concern about fiscal prudence as Bukele seeks a reelection that is now allowed after a ruling from a friendly court.

“Ideally some policy adjustment would be announced early post-elections to appease the market as the current muddle through policy is going to be difficult to repeat in 2024,” Marshik said.