Turmoil in the global bond market has continued this week as yields for Japan’s 10-year bonds hit 3% on Tuesday, the highest since 1998. It is part of a wider trend where bonds in Britain, Germany and France are also hitting their highest yields in a decade or longer and 10-year U.S. treasuries are creeping up to 4.8%. High public debts in many of the world’s leading economies, paired with rising oil prices from the crisis in the Strait of Hormuz and a rush of corporate debt to finance rapid expansion of AI infrastructure has combined to put pressure on interest rates and tighten credit globally. With such conditions, a clutch of democratic countries in South America are near the front line of vulnerability from the knock-on effects of this global trend that is sapping current and future liquidity they depend upon.

What is underneath?

The rise in interest rates in Japan, after so many years of being the sleeping beauty of the G7, is a unique trip wire for emerging markets given the long relied upon practice of accessing cheap and easy liquidity through carry-trade operations against the yen. This is where traders take out loans in yen against a prime rate was persistently around 0%, and took that cash to purchase instruments in other currencies abroad that paid out higher yields, and profit off the spread.

The high popularity of carry-trade operations from yen to Brazilian BRL in the 2000s, for example, played a major factor in pushing up the real’s appreciation against the U.S. dollar during that period. It has been a solid pathway to liquidity for a long time for emerging market traders. But with interest rates going up in Japan, these trades are unwinding and some are facing lost profits or immediate margin calls. Hedge funds and others exposed to the changing tide are liquidating assets elsewhere to cover higher yen-denominated loans.

The wider turmoil in bonds and credit are only adding to the risk-off tilt in the financial markets, and this is raising jitters in South America. The four most exposed countries — Argentina, Colombia, Bolivia and Ecuador — should be worried as the downwind impact starts to gather pace.

• Argentina is the most exposed right now, as it is on a slow financial recovery path under President Javier Milei’s radical reform program. It is still challenged in building up its scarce dollar reserves and has been toiling under heavy austerity measures to get its sovereign rating up and regain access to global bond markets to roll over its existing stock. The timing of the external shock is not great for Milei. Worse yet, unwinding carry-trade positions causes downward pressures on leveraged positions across agricultural commodity futures, so the cost of carrying inventories is increasing. This goes to the heart of what Argentina produces and exports to generate hard currency, and it is facing non-stop debt service payments on its sovereign bonds and to the International Monetary Fund (IMF) now and for years to come.

• Colombia is also in a debt pinch, and newly-inaugurated President Abelardo de la Espriella inherited a fiscal mess just before a massive earthquake hit the country and damaged critical infrastructure in an important region. International funds holding local currency government bonds are exiting their positions to cover losses elsewhere, and this will push that value of Colombia’s peso down. In turn, this will fuel inflation on imports and increase pressure on the central bank to keep interest rates high. The resulting increase in debt service costs for its public debt stock just adds another burden on the new government, which had promised to embark on a top-to-bottom conservative economic and fiscal reform. Now the political cost for such a move, however needed, will go up for Abelardo.

• Bolivia also has critically low foreign reserves and its central bank has maintained fixed exchange rates. After decades of misrule by the Movement for Socialism (MAS), the country’s natural gas and mining sectors have become dilapidated and inefficient despite the critical role those exports play in supplying hard currency. With cash evaporating from the credit markets, Bolivia will have less access to trade credits or multilateral support programs and fresh capital inflows are drying up. A collapse of the exchange rate regime may become a real possibility if the black market for dollars grows big enough.

• Ecuador is a dollarized economy, so it can’t take protective measures to absorb external shocks or keep its exports competitive. With bond yields spiking across the globe, Ecuador will find it harder to roll over its own maturing debt. You would think the surging price of crude oil resulting from the Iran War would help Ecuador as a crude exporter, but it isn’t. Ecuador depends on imported refined fuels in its domestic economy, and those prices are soaring and the government’s fuel subsidy programs are a fiscal drain on any crude export revenues. The country is trapped in an unfavorable scenario it can’t get out of easily.

Our take:

Aside from the four at most risk, other democracies in the region will feel some level of impact as the bond rout continues. Brazil has a gigantic dollar reserve cushion to absorb external shocks, and has a small foreign debt stock. But rising global yields will push up Brazil’s benchmark Selic rate to curtain capital flight and depreciation of the real. That will drive up local currency debt service costs as budget deficits continue to increase, and the presidential election is set for October. Whoever takes power in January will have to face a more restrictive borrowing climate.

The governments of Peru, Uruguay and Chile have sufficient firepower to fend off the effects of bond and credit turmoil right now. Peru’s balance sheet is exceedingly healthy for a country struggling through so many institutional crises in the past decade. Chile’s reserves are healthy and its net debt is under a third of GDP. Uruguay has the lowest sovereign risk spread in Latin America and, like Chile, has maintained high fiscal discipline regardless of the left or right inclinations of its governments.

But the private sector in South America, with all its complexities, will face a range of challenges as liquidity dries up in the global markets. Should there be a spillover from bonds to equities, and the stock markets in the U.S. and Europe enter serious correction territory in the near future, the picture might darken further. Should export markets soften and commodity prices tumble, the economic engines of even the more resilient countries will face inevitable headwinds. It is nowhere near that stage today, but the risks are becoming more visible for policymakers and political pundits. The governments down here had best prepare their most convincing and substantive messaging for whatever is coming if they want to retain the confidence of their own investors and asset holders should turmoil convert into panic.

Sidenote to Readers:

My apologies for not following through on publishing last Monday as promised. Events have overtaken my ability to catch a free moment to put three and four thoughts together on events. But traveling through Brazil this week has given me more than enough material for returning to our regular Friday schedule the day after tomorrow. And yes, it’s going to be about Alexandre de Moraes — one couldn’t imagine this scandal to get any worse for him — and a lot more can happen in the next 48 hours. In any case, it promises to be spicy. Stay tuned.

However, the polling released this week still shows Lula leading Flavio by smaller margins than previous weeks. It follows a cascade of damaging news reports on the federal probe into Lula’s son Fabio Luis, known as Lulinha, and his alleged attempts at influence peddling. A Datafolha poll this week shows Lula ahead 39% to 33% with Caiado (5%) and Santos (4%) far behind in the first round voting. Flavio has consolidated a lead among evangelicals but has tied Lula with men and is far behind among women voters.

A BTG/Nexus poll of second round scenarios shows Lula ahead of all his opponents with 46%, and Flavio (45%) and Caiado (42%) in closer range than the others. An important number of undecideds or those pledging to vote blank remains in that poll.

What is underneath?

While there was widespread disagreement with the decision by Lula and Bolsonaro to skip the first debate, particularly among journalists, it was also smart politics for each for different reasons. The incumbent has been dogged by questions about the investigation into his son that have been timed around the official launch of his re-election push. He has said his son should face justice, the investigation should be thorough, and cannot really say much more on a matter not implicating him. But those questions would have likely dominated the debate and there was no upside for Lula to join in.

For Flavio, an absent Lula would have been a tempting target had the senator been the only leading candidate to show up. But Bolsonaro would have also faced a pile-on of criticism from the rest of the candidates, most of whom hail from the center-right or the far right and have nothing to lose in attacking him. He would have become a punching bag and the coverage would have been mostly negative for him.

Indeed, Caiado and Santos did go after Flavio, with Santos being particularly aggressive. This not only follows an increasing pattern in the first round campaign, but it also points to a center-right in disarray rather than united against Lula. For most in that jumbled firmament, the problem is Flavio himself.

Last month, the head of Bolsonaro’s conservative Liberal Party (PL) said that Flavio “was not prepared to be a candidate” when his father, former president Jair Bolsonaro, anointed him as the nominee. The comment reverberated at a time when former first lady Michelle Bolsonaro, who had wanted to be the candidate but was passed over by her husband, went public with the bitter family rift. But there was wider discontent on a number of fronts that paved the way for the disunity taking hold.

The center-right came into this election cycle with political momentum unlike what has been seen in a generation. The PL and other conservative parties, along with the non-ideological “Centrão” — the Social Democratic Party (PDS) and the Brazilian Democratic Movement (MDB) — intensified their grip on Congress in 2022 while Lula won the presidency by a hair. The 2024 municipal elections were a triumph for the center-right, with the Centrão and conservatives wiping the floor with Lula’s leftist allies across the country, and stitching together a national network of municipal machines that would be unbeatable if it had a uniting figure running for president this year.

Flavio was not seen as that uniter at all from the start. After he emerged as Jair’s one and only choice, the conservative Republicanos of São Paulo Governor Tarcisio de Freitas declared they would remain neutral in the presidential first round. The PSD, which by far controls the most municipal political machines, decided to run its own “pure blood” ticket with Caiado at the top, designed to maximize their leverage in their kingmaking role in the second round. Other conservatives like Santos emerged to challenge Flavio, and the Bolsonaro-aligned Partido Novo put forth its own ticket.

For the Centrão, anyone named Bolsonaro at the top of the ticket would be laden with political baggage that could only complicate the campaign and, if victorious, make governability even more difficult. The Centrão’s raison d’etre is governing, and the experience of trying to do so with President Jair Bolsonaro, by many accounts, was a punishing experience for them and their conservative fellow travelers. Structural reforms to modernize Brazil’s economy seemed tantalizingly close, and the fiscal upsides appeared rosy for those dedicated to the profession of governing. But the elder Bolsonaro was an erratic and distracted leader consumed with cultural issues and conspiracy theories, bristling at having to build coalitions or take any political advice. The onset of the Covid pandemic in 2020 and Bolsonaro’s handling of it largely convinced his centrist allies that he couldn’t be counted on to run the government to their liking.

It was Flavio’s elevation, and not Flavio himself per se, which initially stirred the disarray. Many had hoped Bolsonaro would bless the candidacy of a new conservative, like Governor Freitas, and seal the center-right’s chances for a landslide. Every leader in the center-right had been making it clear that some kind of pardon, amnesty or commutation of the former president’s prison sentence for his role in an attempted coup in 2023 would be assured by a center-right president who won in 2026. But nothing dissuaded Jair Bolsonaro from insisting on Flavio or nobody.

Had Flavio been a dynamic senator who had helped broker deals with Congressional allies over the last eight years in office, and a calm but charismatic member of the Bolsonaro clan who appealed to the broader public, this would have been a much easier sell. But the elder son of the former president has not championed anything of note in the Senate during his time in office. While far more mild-mannered than his brothers and father, he lacks the charisma and television appeal that average voters prefer to see in a candidate.

All his time in public office, Flavio’s greatest claim to fame is that he’s been a loyal acolyte of his father on all subjects under the sun, and willing to go to any length to show that loyalty. To those in the wider center-right coalition, this means that instead of a talented political operator with a public mandate that can lead a cabinet and a center-right governing coalition in Congress, they will be navigating Bolsonaro family drama for another four years if they are all elected together in October. They had been willing to suspend disbelief and allow Flavio to surprise them with political talent and skills they hadn’t properly credited him with. But that hasn’t panned out, and Flavio has never been able to either gain a lead over Lula or achieve a net-positive opinion rating since the campaign formally began.

Our take

The next president will face serious policy challenges and will need to be able to govern effectively to face them. The federal deficit has ballooned and there will be intense pressure to rein in spending under the country’s strict fiscal framework. Economic growth is stagnant, credit is tight for business and industry and a rise in inflation will swamp debt-laden households. To succeed in tackling these and deeper structural issues, the next president can’t be captive to populist spending pressures nor can he be isolated from the Centrão.

These facts play against Flavio in the second round in every way, both with the leading political players and with the voters. Jair Bolsonaro was someone most of the country was willing to give a chance in 2018, given the mood of discontent with the political establishment on the left and in the center. Now they have the memory of Jair Bolsonaro’s presidency, and while the conservative base remains loyal the vast middle didn’t have so good an experience, and Flavio doesn’t foster new bouts of confidence.

The hunger throughout the center-right to be back in control of the federal government is very palpable. Brazil is the one big standout in South America where center-right government hasn’t yet taken power and put its mark on policy and economic reform. They want to regain the legislative and regulatory initiative in Brazil and restore a sense of order and predictability to government. What unites them is a sense of purpose in what they will do with power once they obtain it. Most in the center-right are willing to work together like they have done at the state and local level heading into this election, and like many of them used to do for decades before politics became so polarized and clouded in populism.

But the perception is that the Bolsonaro clan and much of the PL disagrees with what will be done with power if they get it as the heads of a center-right coalition. It increasingly looks to the rest of the coalition that it will be a return to their experience before, albeit with a President Flavio Bolsonaro as merely a messenger for his father. Jair is banned from holding public office until 2030 and reportedly nurses an angry desire for revenge and retribution for his prosecution, starting with members of the Supreme Court who tried, convicted and imprisoned him.

The campaign heading into the first round of the election is heady, as the Congress and state legislatures will be elected and governors will also either advance to a second round or gain a win. Those outcomes will color the playing field for endorsements for either Lula or his second-round opponent, still most likely to be Flavio Bolsonaro. It will not only be decided by who else does well in the first round among the presidential hopefuls, but what the makeup of the next Congress will be and who will be best able to govern it from the presidency.

I wouldn’t be surprised if the Centrão is already gaming out a possible endorsement of Lula in the second round, and what they would get in return in ministries under their control and the government’s policy agenda. The incumbent president, despite all the flaws and stumbles in his third term, is still one of the most experienced political operators alive and kicking in Brazil today. He must see the writing on the wall, particularly after experiencing the frustration of being unable to lead effectively without a viable governing coalition in Congress.

It is an opportunity that few expected going into this election year. But it may what many will conclude is the only way Brazil can be governed effectively for the next four years. There will have to be compromise and true cooperation, which may be distasteful to the leftist base and some of the more orthodox elements of the Centrão. But Lula ran as such a compromiser in 2002 and won in a landslide after so many crushing defeats. We’ll see what the next two months bring as speculation yields to reality.

The next edition will go live on Tuesday, August 25th instead of this evening. And then after that, the last edition for the month will go live on Monday, August 31.

In the meantime, I’ll be traveling in South America for DCI, not only working but picking up insights and intel I look forward to sharing about what’s happening in the region at this important time. Thanks for following me on the road, and I appreciate the indulgence for the crazy schedule.

The crisis posed an immediate challenge to the new government and the young president, who has never held public office before nor has served in a substantial management post. He won praise for the rapid relief activation on Wednesday, and requested immediate assistance from the United States and U.N. relief agencies to help Colombian crews to locate and rescue the missing and support those made homeless in the affected areas. Abelardo also signed an order establishing a reconstruction fund to coordinate and channel national and international assistance into rebuilding hospitals, schools, homes and infrastructure.

But the leftist opposition, as well as leftist heads of government in other countries, immediately began to publicly criticize the government’s relief efforts.

What is underneath?

The proliferation on social media of literally tens of thousands of videos recorded by residents throughout Colombia as the quake hit were enough of a testament about how serious this disaster was for the country. Many captured old and new structures — cathedrals, university buildings, office buildings, apartments, retail stores, restaurants, gyms, hotels — suffering major damage or fully collapsing during the quake. The images captured in Pereira were among the most heart-wrenching to watch. Some appeared to show residents being seriously injured or killed in the footage.

One week ago, former president Gustavo Petro refused to recognize Abelardo’s election and eschewed the usual peaceful transition. His chosen candidate, Senator Ivan Cepeda, called for public “resistance” to the government in a rally only last Friday and vowed before the earthquake to join Petro in protests clearly aimed at destabilizing the new president. All of this raised immediate concerns that the emergency agencies within the new government would not be ready to respond adequately to the crisis.

The concerns were quickly dispelled. “All the institutions have worked,” María José Torres Macho, the United Nations’ top official in Colombia, told the Associated Press yesterday. “Our ability to be working with them has not been affected by the change of government.”

Colombia has dealt with natural disasters many times in the past, and has substantial search and rescue capacity and knowhow at the national level to address the affected areas. The country has declined a patchwork of foreign offers to send crews except from the United States, which mobilized a package of $26.5 million in humanitarian aid and support being delivered by SOUTHCOM out of Miami.

AP noted that Colombia’s robust national response compared starkly with the slow and plodding response from the government in neighboring Venezuela in June when a pair of powerful earthquakes struck that country:

In Venezuela, acting President Delcy Rodríguez waited nearly four hours before addressing the nation. In Colombia, newly inaugurated President Abelardo de la Espriella announced an emergency command post to oversee rescue efforts barely an hour after the earthquake struck. For weeks, Venezuelan civilians were clawing through rubble by hand. Hours after the earthquake in Colombia, rescue teams were searching for survivors with cranes and excavators. […]

The contrast is a reminder of the differences between the neighboring nations — their political systems, resources and the strength of their institutions — and a demonstration of how those can take on life-or-death importance in catastrophes.

“The differences between an authoritarian regime and a democratic system can be seen clearly in the institutions and in their capacity to respond to an emergency,” said Ronal Rodríguez, a Venezuela specialist at Colombia’s Rosario University. “Crises are also political opportunities.”

Arguably this crisis was a test for both Abelardo’s new government and the “resistance” being led by Petro, Cepeda and the opposition. If either shows more political calculation than responsible leadership in an emergency, it would be a sign of weakness that would not only reflect on them but on Colombia’s institutional integrity.

Curiously, foreign governments aligned with Colombia’s leftist opposition seemed eager and quick in politicizing the earthquake. China, a nation nearly 10,000 miles away, issued a press statement through its state media offering support in search and rescue logistics. When the offer was not responded to immediately by Bogota, China’s ambassador in Colombia wasted little time in fanning rumors of an unprepared conservative president with a social media post demanding that Abelardo “release the name of the official and his or her designated contact person to coordinate international aid for the earthquake victims.” By its petulance, it was a fairly obvious diplomatic ploy that crumbled when the U.N. publicly praised Colombia’s handling of the crisis.

Mexico’s government seemed to also be insistent in sending a rescue crew, which Colombia did not immediately accept and made referrals to the designated U.N. relief body. President Claudia Sheinbaum then went before the media to complain that she had not received “a formal invitation” to send the crew, framing it as some kind of ideological insult. In fact, as the Colombian media has reported, the country has plenty of elite rescue crews to handle the crisis at its current scale, and deployed them at great speed on Wednesday. Hours after the earthquake, the government had set up means to channel aid through the U.N. and humanitarian aid began arriving in Pereira and other devastated cities from Mexico and other foreign donors by Thursday. The Mexican rescue crews appeared to be sexier headline bait in Mexico City for Sheinbaum’s government.

The Colombian opposition, however, wasted no time in taking these public complaints and trying to turn them into political capital. Senator Alejandro Ocampo and other allies of Petro and Cepeda spent Thursday putting out statements accusing Abelardo of refusing aid from leftist governments for ideological reasons. Their efforts helped provoke false reports on Thursday that Colombia was only accepting rescue crews from four “ideological allies” — the U.S., Israel, Ecuador and El Salvador — and rejecting them from Brazil, China, Mexico and (no kidding) Venezuela. Other opposition leaders then claimed the Ecuadorian teams — that were never actually requested or being sent — were being prevented from arriving by Abelardo’s government.

Our take:

We are still early in the crisis, and the search and rescue efforts are still ongoing. Much like the horrifying videos of the earthquake itself, social media has also documented the heart-rending rescues of old people, children, mothers, fathers and pets from the rubble in different cities.

But the AP’s take on Colombia’s response compared to that of the regime next door in Venezuela in June is the more apt political analysis than the shameless carping by the Chinese and Mexican governments or the leftist “resistance” inside Colombia. If Abelardo was going to show cracks or signs of weakness during the crisis, it was much more likely to be in these first days. As a result, either the president’s personal competence is less relevant to the Colombian government’s installed capacity to respond to natural disasters, or he has competently led the country through this so far. Neither of these two possibilities will satisfy his critics at home or abroad who’d hoped to gain political advantage from this tragedy.

Indeed, the most severely affected area in the coffee-producing region voted strongly for Abelardo while other impacted areas like Cali and Andean regions were either mixed or more in favor of Cepeda. As of tonight, they are all getting support from Bogota according to humanitarian groups and the U.N. teams on the ground.

Regardless, there is no question that Colombia is nothing like the decrepit failed state next door that so many of Abelardo’s critics defended and propped up for years before the seizure of Nicolas Maduro last January. The pantomime efforts by those same leftists to claim the abandonment of affected areas by the state didn’t pan out in reality, and their shameless attempts should surprise no one. The election this year was very close, and the opposition needs to tread very carefully after Petro’s shambling exit from office and Cepeda’s initial image as a sore loser in the first round.

That said, there is still plenty of room for Abelardo to succeed, fail or land awkwardly somewhere in the middle as the death toll becomes evident, the rescue operations are examined and the recovery efforts proceed. When the survivability window closes and bodies begin to be recovered, there will naturally be both mourning and recrimination as one expects in a democracy. How Abelardo handles that aspect, and how much accountability or credit he takes for himself for the failures and the successes, will be the next test of his leadership. Personalizing this tragedy in himself as leader will likely polarize rather than unite the country, and his instincts will be greatly challenged. So far he’s done an exemplary job for a novice, but we’ll see how it goes from here.

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The leading candidates are leftist Senator Ivan Cepeda, center-r…

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