The Latin market rally took a breather this week, sparking fears that rising US interest rates or lacklustre global growth will spread regional panic and cut back sky-high stock and bond prices.
Ramin Toloui, executive vice-president of Pimco, told Emerging Markets: There is a real danger that the market has positioned itself for a more favourable US economic growth scenario than will materialize.
Bertrand Delgado, Latin America analyst at Roubini Global Economics, said: There has been over-exuberance combined with large amounts of liquidity that is going somewhat beyond the regions economic fundamentals.
Financial markets last week seesawed, driven by contrasting sentiment on China and US exit strategy from stimulus policies, US growth and western sovereign debt.
US equities finished above their January high on Friday, buoyed by the Federal Reserves declaration on Tuesday of intent to keep interest rates at historic lows for a prolonged period. But Latin markets after staging massive rallies since last spring were largely unchanged.
The MSCI All Country World Index, the benchmark for global equities, was up 0.9% and the JP Morgans Emerging Market Bond Index Global tightened by 1 basis point (bp) to 269bps over US Treasuries.
Sovereign bonds, from Argentina and Venezuela, saw risk premiums decline the most, as investors chased yield. Latin currencies underperformed emerging Europe, as the dollar strengthened and central banks in the region intervened to curb currency strength to boost exports.
The most notable sign of weaker risk appetite came in Brazil, when a slew of firms last week postponed or downsized initial public offerings. Investors are increasingly concerned about high equity valuations, the fact the rally has largely been driven by stimulus policies and fears that markets may reprice global economic performance at a lower level, Paul Bisko, senior emerging markets analyst at RBC Capital Markets, said.
The margin between developing world bonds and US government bonds, seen as safe-haven assets, has narrowed dramatically over the past year and now stands at pre-crisis levels.
Toloui of Pimco said: The risk/return profile of emerging markets may look less attractive in the near-term due to high valuations while markets are still assessing US economic outlook.
He added that investors, faced with relentless inflows into emerging market bonds, are reluctantly snapping up assets which, combined with record low US interest rates, could in the medium term create bubbles in Latin debt markets.
Delgado at RGE said Latin assets may have room to rally if capital flows maintain their frenzied pace once regional central banks put up interest rates. However, if and when the Federal Reserve hikes rates, there could be a horrible correction in Latin America, he said, citing in particular the overvaluation of the Brazilian real.