Top Emerging Market Bond Rally Tested in Deja Vu Ecuador Vote

(Bloomberg) -- The best rally in emerging markets this year hinges on the popularity of one person: Daniel Noboa, the 36-year-old heir to a banana fortune.

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Less than six months into his administration as Ecuador’s president, Noboa has cracked down on gang violence, hiked taxes and made progress negotiating a deal with the International Monetary Fund — all of which makes the nation’s dollar bonds the best performers among developing nations.

The millennial leader faces a key test Sunday when Ecuadorians will vote on security measures he proposed to continue fighting organized crime in a country gripped by spiraling violence.

For investors, the vote results are key to determining Noboa’s popularity and whether Ecuador’s sovereign debt can extend its rally or repeat a crash seen last year after the failure of former President Guillermo Lasso’s own referendum.

“President Noboa’s success in the upcoming April 21 referendum will be crucial for passing reforms, along with gaining a larger representation in the National Assembly,” said Ricardo Penfold, a managing director at Seaport Global in New York.

In addition to stronger use of the military, Noboa is seeking approval for the extradition of Ecuadorian citizens to fight crime and to overturn constitutional bans on temporary work and international arbitration. But the vote is taking place amid an energy crisis, with the president ordering businesses and government offices shut down Thursday and Friday due to a crippling lack of electricity he blamed on drought but also alleged sabotage.

Compared with Lasso, however, who had an approval rating of 13.5% at the time of his referendum, Noboa, polling at 66.8% as of April 12, heads into the vote in a much stronger position, according to Comunicaliza.

“What we learned from the Lasso referendum fiasco last year is that Ecuador’s voters tend to not really care or read the questions,” said Risa Grais-Targow, an analyst at Eurasia Group who sees more upside on the bonds if the results from the referendum are favorable. “It’s all about how they feel about the president.”

Holders of Ecuador’s debt have been on a roller-coaster ride over the past two years. Sovereign notes were among the worst performers in 2023 as Ecuador went through an impeachment bid, an assassination of a presidential frontrunner and a sharp escalation of narco-gang violence.

Since then, bonds have risen to the top in emerging markets, as Noboa leveraged a security crisis into an opportunity to push through reforms, gaining favor with global investors and acceptance among Ecuadorians.

The extra yield investors demand to hold Ecuador’s dollar bonds has dropped over nine percentage points this year to 1141 basis points, according to JPMorgan Chase data. The risk premium has returned to levels of February 2023, just before Lasso’s referendum defeat led to a crash in the nation’s sovereign debt.

“Noboa’s security strategy is providing him with unprecedented governability and political support,” Grais-Targow said. She added that the young leader “has better prospects for political stability than what I’ve seen” since the administration of former President Rafael Correa from 2007 to 2017, who leads the Citizen Revolution party and is in self-imposed exile due to a corruption conviction.

Chris Preece, a portfolio manager at Pictet Asset Management, said the market expects the referendum to pass given Noboa’s successes so far.

“Noboa has exceptionally high polling. He’s very popular. He hasn’t been able to completely clamp down on the violence, but it’s drastically improved,” said Preece, who holds an overweight position on the bonds.

Ecuador bonds have returned more than 60% to investors this year, compared to an average of 0.1% across emerging market sovereign notes, according to data compiled by Bloomberg.

With fiscal measures and IMF negotiations largely priced in, a favorable outcome on Sunday would be a “powerful sign” of popular support for Noboa ahead of the 2025 elections and thus drive further gains, according to BancTrust & Co. strategists Juan Sola, Agustin Costa and Ramiro Blazquez. They expect the bonds’ spread to further compress 200 basis points.

Investors like Polina Kurdyavko, head of EM debt at BlueBay Asset Management, are waiting on results to decide whether to bet on Ecuador.

“It’s very difficult to make projections in Ecuador beyond a 3-, 4-, 5-month horizon,” Kurdyavko said. “So for now we had decided more to sit on the sidelines and see how the referendum evolves and whether the policy sustainability can be assured.”

--With assistance from Stephan Kueffner.

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