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EM BY EM #15 – Ecuador General Election as a catalyst?

Plenty of bets in LatAm carry trades unwound this week on the back of BoJ YCC tweak. But perhaps the LatAmsphere has a USD winner short term?
2023-08-04

Sovereigns are getting killed across the board this week and it is indeed difficult to find much optimism in that many assets as of this week. We take some encouragement from being long the least worse of a bad bunch and those few areas that have actually performed.

With that in mind its probably a rather provocative proposition to suggest an event-driven sovereign EM sovereign credit play on a serial default criminal that may offer some decent risk/reward in the short term.

Nevertheless, I have done some reseach on Ecuador due to the upcoming election and I think it may serve as an interesting positive catalyst for an otherwise risky asset class (Lat AM EM).

What makes Ecuador so interesting from an economic perspective in comparison to peers?

Ecuador has effectively tight itself to the pole by adopting the USD as its currency. Is it a recommendable cure for pathologies that are often so prevalent in the EM space? Disputable. Some academic research suggests that if preluded by a USD shortage (looking at you Argentina) it may create an unpleasant “sudden stop” (see Ivan Wernings et al new academic paper right here), but perhaps it is the least worse option, or at least it forces politicians away from central bank monetarization of public liabilities.

Chart 1: Argentina vs Ecuador CPI

Plenty of bets in LatAm carry trades unwound this week on the back of BoJ YCC tweak. But perhaps the LatAmsphere has a USD winner short term?
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