Ecuador's Bond Rally Reverses Amid President's Falling Approval and Investor Concerns

Key Takeaway

• Ecuador's dollar bonds, which rallied 80% since President Daniel Noboa took office, are now declining with a 3.2% drop in the past month.
• Investor sentiment is waning due to Noboa's falling approval rating (59% from 80%) and upcoming early 2025 elections.
• Fiscal and security challenges, including potential VAT hike setbacks and electricity supply issues, add to investor concerns.

Ecuador's Bond Rally Reverses

Daniel Noboa, Ecuador's millennial president, initially won over investors with promises to revitalize the economy and address rising crime. However, six months into his term, some investors are pulling back from what had been a highly profitable trade in emerging-market debt. Ecuador's dollar bonds, which had rallied 80% since Noboa took office in November, are now seeing reduced interest. Bank of America Corp recently downgraded its recommendation on these bonds, and Goldman Sachs & Co. and BancTrust & Co. have also closed their bullish positions.

The extra yield investors demand to hold Ecuador’s dollar bonds has widened by more than 130 basis points in May, according to JPMorgan & Chase data. The country's debt has been one of the worst performers among emerging-market government notes over the past month, declining by 3.2%, as per Bloomberg data. This marks a significant reversal from earlier in the year when Noboa's tax reforms and a $4 billion loan agreement with the International Monetary Fund spurred investor interest. Prices on the 2035 note had risen to as much as 56 cents on the dollar from around 36 cents but have since fallen to around 52 cents.

Declining Popularity

Noboa's popularity has also seen a decline. A recent Comunicaliza poll showed his approval rating at 59%, down from 80% in January. This drop in popularity is concerning for investors, especially with the upcoming early 2025 election. "Investors are aware that the lead-up to the early 2025 election will be very complicated," said Sarah Glendon, a senior analyst at Columbia Threadneedle Investments. She added that while Noboa benefits from the absence of a strong opposition, he faces challenges such as a weak economy and security and electricity crises.

Adding to the concerns, Ecuador's economy is expected to slow this year, and the dry season starting around August could further affect the nation's electricity supply, which has already been interrupted due to drying hydroelectric reservoirs. These factors could further erode the government's popularity, according to BofA analysts, including Lucas Martin. They noted that previous leader Lasso also saw his popularity erode quickly after an initial high following a successful vaccination campaign.

Fiscal and Security Challenges

Ecuador's constitutional court is currently debating the legality of a hike in the value-added tax that Noboa implemented as a revenue measure. A setback in this area could add to fiscal pressures. Despite these challenges, some firms, including AllianceBernstein, still see potential in Ecuador's credit from a medium-term perspective. Jared Lou, a money manager at William Blair International in New York, mentioned that a potential issuance of blue or green bonds to buy back debt later this year could reduce risks. Additionally, there will be a step-up in coupons in August.

However, Noboa will need to carry out a fiscal consolidation program while managing to prevent a further decline in his popularity before the general elections, expected in February. He also faces a complex security situation, with drug traffickers causing significant issues across the country. "Ecuador has 'very few' positive catalysts in the near term," said Ricardo Penfold, a managing director at Seaport Global in New York. "We will be in a period of limbo for a while."

Street Views

• Sarah Glendon, Columbia Threadneedle Investments (Neutral on Ecuador's political and economic situation):

  "Investors are aware that the lead-up to the early 2025 election will be very complicated. While it is true that Noboa benefits from the absence of a strong opposition, he also faces a weak economy, as well as security and electricity crises."

• Lucas Martin, Bank of America (BofA) (Bearish on Ecuador's fiscal stability):

  "Recall that Lasso enjoyed very high initial popularity following a successful vaccination campaign, but it eroded quickly afterward."

• Jared Lou, William Blair International (Cautiously Optimistic on Ecuadorian bonds):

  "A potential issuance of blue or green bonds to buy back debt later this year could reduce risks, and there will be a step-up in coupons in August."

• Ricardo Penfold, Seaport Global (Bearish on Ecuador’s near-term outlook):

  "Ecuador has very few positive catalysts in the near term. We will be in a period of limbo for a while."