Prospects for the U.S. and Global Economy in 2008
I thought it would be useful to post some high-frequency historical charts on both currency and 5-year dollar sovereign CDS spreads for each individual country in the LatAm region as more attention has been given to the analysis of those two variables in a comparative way.
Sovereign CDS spreads have surged since the no-rescue bankruptcy of Lehman Brothers on Sep-15th. For instance, Mexico’s spread jumped from 165bps to over 587bps, Brazil’s from 200bps to over 586bps, Chile’s from 69bps to over 322bps, Colombia’s from a little over 29bps to more than 600bps, while the usual suspects, Argentina’s and Venezuela’s spreads went from 942 bps and 873bps to over 4019bps and 2325bps respectively.
During this same period, the Brazilian real lost over 23%, the Mexican peso nearly 24%, the Chilean peso almost 27%, the Colombian peso a little more than 15%, while the Peruvian sol lost only 4.5% on the back of huge reserves and heavy intervention, the Argentine peso lost less than 7% due to a heavily managed FX market, and finally the Venezuelan Bolivar was flat due to the currency board
Another interesting observation is the movement on CDS spreads on the week of Oct-20th to Oct-24th when the tone of the financial crisis seem to have intensified. Brazil’s spread jumped 81.7%, Mexico’s by 85.7%, Chile by 69.3%, Colombia by 84.3%, Peru by 76.5%, Argentina by 40%, and Venezuela by 39.1%.
Overall, despite the abrupt movements seen on the recent weeks and the panic-like character of the crisis, there’s still a bit of fundamental basis playing within the region. The country that seems to have suffered the least in terms of the two financial indicators we use here is Peru, where the level of reserves is quite impressive (over 26% of GDP – the biggest in the region). The buffer has allowed the CB to perform intensive interventions on the FX market. On the top of that, when we analyze the balance of payments of the LatAm countries as well as the borrowing requirements for 2009 we observe that Peru has the best solvency situation vis-à-vis the international reserves. We also believe that if it wasn’t for Argentina’s high level of international reserves over GDP (more than 14.2% – the second highest in the region) CDS spreads could possibly be suffering more while the management of the exchange rate by the CB would be significantly more difficult.
We tend to see an increase in the relationship between FX markets and CDS spreads in times of high volatility but we still cannot argue in favor of one over another in terms of what is the best indicator of overall fundamental conditions. I just mentioned that CDS spreads seem to have suffered nearly equally in Mexico, Brazil and Peru, while it seems that the FX market response among the three countries could be a better indicator of the quality of an individual’s country fundamentals.
On the charts below, the light-blue lines are the foreign exchange rates in local currency to the dollar scaled on the left-hand-side, while the bold dark-blue lines represent the CDS spreads, which are scaled on the right-hand-side of the graph in basis points.
I invite readers to post their comments and add to the discussion above.