El Salvador Bond Rally Continues Amidst Bitcoin Adoption
Investors in El Salvador international bonds have been reaping significant rewards this year, with returns of 60% as the country's debt rebounds from previous concerns of default. Despite initial challenges, some investors believe that the rally in El Salvador bonds is not yet over. Last year, El Salvador faced various hurdles, including rising tensions with the United States, uncertain prospects for a financing deal with the International Monetary Fund (IMF), and the impact of adopting Bitcoin as legal tender. These factors led to a sharp decline in El Salvador bonds, dropping to a quarter of their face value in July. However, fast-forwarding to the present, two surprise debt buybacks have significantly lightened the country's payment schedule until 2027. Furthermore, the appointment of a former IMF official as an advisor to the finance ministry has sent positive signals to the market. For instance, a bond maturing in 2025 is now trading at 89 cents, compared to around 27 cents a year ago. "In the summer of 2022, El Salvador bond prices were divorced from fundamentals," noted Aaron Stern, managing partner and chief investment officer at Converium Capital in Toronto, who has been holding the country's bonds since last year. Despite initial concerns about the government's commitment to repayment, El Salvador now offers attractive value when compared to other emerging market sovereigns. The appointment of ex-IMF official Alejandro Werner has revitalized hopes for a potential IMF deal in the future. Additionally, there is an expectation of more structured policy-making in the country. El Salvador's President Nayib Bukele has maintained high approval ratings, and the need for continued access to the market in a dollarized economy is recognized. El Salvador's debt-to-output ratio, which stood at 77% in December, is forecasted to drop further this year before rising to 78% in 2024. The total public debt decreased from $25.4 billion at the close of 2022 to $19.7 billion in May, according to Refinitiv data. Currently, Salvadoran dollar bonds offer yields ranging between 14% and 18%, making them among the best performers in the first half of the year with total returns nearing 60%. Despite the impressive run, some investors believe it is not yet the time to cash out. JPMorgan recently upgraded its recommendation on El Salvador's hard-currency debt to "overweight" from "market weight," citing a constructive external and fiscal outlook in the short term. However, concerns arise about fiscal prudence and policy adjustments post-elections, as President Bukele seeks reelection following a favorable court ruling. El Salvador's bond rally has been remarkable, driven by carry (yield) as a primary driver of total returns. Investors are cautious about taking profits too early in a year dominated by carry-driven returns. El Salvador stands out as one of the highest yielding "performing" distressed credits. It would likely require a significant fiscal deterioration or a shift in the political tone towards the market to trigger another bond sell-off. In conclusion, El Salvador's international bonds have experienced a notable rally, generating substantial returns for investors. The country's debt has rebounded from previous concerns, driven by the buybacks and positive market signals. While some caution about future developments, the constructive external and fiscal outlook, along with high yields, continue to attract investors. The upcoming presidential elections and potential policy adjustments post-elections will be crucial factors to monitor in the coming years.