Emerging-market bulls are taking notice of Colombia, hailing it as a rising star and forecasting its currency will be a world beater in 2018.
The Colombian peso USDCOP, +0.00% has climbed more than 5% against the U.S. dollar this year, according to FactSet. One dollar fetched 2,834.44 pesos on Wednesday.
“Colombia’s peso will be one of the best performers in emerging markets this year,” said Sergi Lanau, deputy chief economist at the Institute of International Finance.
Relatively high interest rates, which make it a carry trade destination, as well as a stable political and economic outlook and rising oil prices, are fueling bullish enthusiasm for the Latin American country.
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In mid-April, the U.S. dollar, which has been broadly stronger against major currencies, fell to a nearly three-year low against the Colombian unit, as the peso has climbed in lockstep with oil prices. Colombia is a major oil exporter — bigger than other favorite Latin American investment destinations such as Mexico, for example — and its currency is closely tied to the oil price.
In May, crude oil traded above $80 a barrel for the first time in almost four years, before retreating on worries over a potential output boost by the Organization of the Petroleum Exporting Countries and its allies in an effort to make up for shortfalls from Iran and Venezuela. Higher oil prices also help narrow the country’s current-account deficit, which has traditionally been on the larger side, Lanau said.
Brent crude for August delivery LCOQ8, -0.52% the global oil benchmark, settled at $75.38 on Tuesday. While down 3.5% so far in June, the global crude benchmark remains up 12% in 2018 and nearly 50% over the last 12 months.
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But it’s not just oil prices that have brightened Colombia’s future. After 50 years of conflict, the government finally reached a peace treaty with guerrilla group Revolutionary Armed Forces of Colombia, or FARC, in 2016. Later this month, Colombians will also vote for a new president.
“The peso’s outperformance has been driven particularly by higher oil prices and optimism around the presidential election next week, which I don’t think will bring big surprises” with center-right candidate Iván Duque Márquez expected to prevail, said Tania Escobedo, Latam FX strategist at RBC, in an interview.
Colombians vote in the second round of the presidential election on June 17, with Duque, a protégé of former President Álvaro Uribe, facing off against left-wing candidate Gustavo Petro, a former Bogotá mayor and ex-guerilla from the defunct M-19 movement. Duque was the top vote-getter in the first round, taking 39% of the vote in a five-candidate field, while Petro took 25%. That said, a win by Petro, which would be a wild card for markets, can’t be ruled out, analysts said.
“This election bears a lot less risk than others in Latin America, for example the one coming up in Mexico,” said Lanau. In Mexico, newcomer and left-wing populist Andrés Manuel López Obrador appears on track to win the July 1 election. “Investors are very attuned to elections at the moment, given the surprise results we’ve seen all over," Lanau said.
Investors also “look at Colombia as a decent carry currency, plus there have been improvements in economic data,” said Eamon Aghdasi, emerging markets strategist at State Street Global Investors. “The economy is generally on the right track and Colombia has decent real yields. There aren’t a lot of places in the world like that.”
In a traditional carry trade, investors borrow the currency of a country where interest rates are relatively low and buy higher-yielding assets in another currency.
Indeed, the proportion of foreign holders of local currency assets has increased, Lanau said, in part because some emerging market indexes increased the weighting of Colombia.
The country’s key interest rate sits at 4.25%. However, the central bank could cut the rate by 25 basis points at its June 29 meeting, analysts said. Consumer price inflation stood at 3.1% in April, in line with the bank’s target of 3% plus/minus 1%. May inflation ran a little hotter at 3.2%, still giving the central bank room for a possible rate cut.
But on the whole, relatively low inflation, a supportive policy rate, healthy global growth and stability in oil prices should support further growth this year and push the peso higher, analysts said.
“Though domestic risks for the peso include slow fiscal consolidation and a high current-account deficit, I think idiosyncratic risks for the Colombian economy are relatively lower than those of Mexico and Brazil,” Escobedo said.
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