Venezuelan Bonds: Pricing Hugo Chavez's Demise

While I am certainly no fan of Hugo Chavez, I do not wish terminal illness on anyone as a God-fearing Christian. That said, financial markets make it their business to peer into the crystal ball to foresee the future. Will Venezuela open itself up again to foreign investment in the energy sector, for instance? Nowhere is the practice of divination more visible than with Venezuelan sovereign debt, which has been on a roller-coaster ride as of late given its president's reportedly serious medical condition.

News reports out of Caracas are, in a word, manic. Let me provide some examples here. Early Friday morning, Bloomberg was commenting on the rally in 15-year bonds as Chavez's situation was viewed as dire and he was in Cuba for advanced medical treatment. Whereas Venezuelans used to regard his trips to Cuba with more curiosity, they had supposedly grown indifferent:

“In times past, when he’s gone to Cuba for treatment, there’s always been video of him getting on or off the plane or he would make a phone call to Venezuela’s state TV or pose with a picture of the Granma newspaper with Fidel for a sort of proof of life,” Russ Dallen, the head bond trader at Caracas Capital Markets, said today in a telephone interview from Miami. “But we haven’t had any of that for going on 21 days now. We’re getting closer to the end.”

The yield on Venezuela’s benchmark 9.25 percent securities due in 2027 fell 33 basis points, or 0.33 percentage point, to 9.18 percent at 3:12 p.m. in Caracas, according to data compiled by Bloomberg. Yields have plunged 1.74 percentage points since mid-November. The bond’s price rose 2.62 cents today to 100.50 cents on the dollar, the biggest one-day rally since June 2010.

Well guess what; just a few hours later Chavez made a semi-triumphant display returning home. So bond prices again fell:

Venezuelan bonds fell, pushing yields up from the lowest level since February 2008, after President Hugo Chavez broke a 21-day silence and returned from cancer treatment in Cuba. The yield on Venezuela’s benchmark 9.25 percent securities due in 2027 rose 26 basis points, or 0.26 percentage point, to 9.43 percent at 10:12 a.m. in Caracas, according to data compiled by Bloomberg. The bond’s price fell 2.02 cents today to 98.58 cents on the dollar, the biggest one-day drop since Oct. 9...

State-run Venezolana de Television broadcast images of Chavez waving and smiling as he came off a plane. The self- proclaimed socialist, who has seized companies and imposed currency and price controls during his 14 years in office, said he was “very excited” to be back in Venezuela.

Over the weekend, Hugo Chavez further reached out to the electorate which had elected him to another term and whose fourth inauguration is set for 10 January 2013. Hoping for the best but expecting the worst as the saying goes, Chavez has anointed his successor in Vice-President Nicolas Maduro. Previously, Chavez reportedly did not disclose the exact nature of his condition and the accompanying need for repeated trips to Cuba:

Venezuela’s president Hugo Chávez has revealed that he needs more cancer surgery and endorsed vice-president Nicolás Maduro as his successor if his condition should worsen...“It is absolutely necessary, absolutely essential, that I undergo a new surgical intervention,” said Mr Chávez in a national television broadcast on Saturday night, despite repeatedly having claimed to be free of cancer.

“With God’s will, as on previous occasions, we will come out of this victorious,” said Mr Chávez. He said doctors had found a recurrence of “some malignant cells” in his pelvic area, from which tumours have previously been removed. He has never disclosed the precise type or severity of his cancer.

Given the clear-cut majority Hugo Chavez attained in the most recent election, I simply do not think that "Chavismo" will disappear with the man should he step down from office for whatever reason. In any case, it will be a test of whether his personal popularity is mostly attributable to what Max Weber called "charismatic authority" or to deep-seated grievances against Western and mestizo domination Chavez routinely rails against. I am sorry to disappoint the markets, but I suspect it's the latter. It is unlikely that Venezuela will have a radical change to pro-market leadership to replace him anytime soon.

At any rate, I am convinced that the best outcome for Venezuela anyway, especially given its highly divided electorate, is not a sharp turn towards a neoliberal regime, but rather a market-friendly brand of socialism of the sort that Brazil has exemplified with (lapsed dependencia theorist) Cardoso, (labor unionist) Lula and now (former Marxist activist) Dilma Rousseff. All those three Brazilians were firebrands in their youth, but eventually grew up understanding the need for economic development and to play along to some extent with the damn capitalists. May Venezuelan leadership go down the same route in due course.

In the meantime, don't be surprised to see even more bond gyrations as markets open on Monday.

12/10 UPDATE:  As predicted, bond yields are falling in expectation that a post-Chavez administration will come into power soon...

Venezuelan bonds surged, sending benchmark yields to a five-year low, as speculation mounted that President Hugo Chavez will be unable to complete his third term after he acknowledged a recurrence of his cancer. The yield on the government’s dollar bonds due 2027 plunged 57 basis points, or 0.57 percentage point, to 8.79 percent at 10:52 a.m. in New York as traders anticipated a new administration taking office and courting the investment Chavez drove away. The bond’s price soared 4.61 cents to 103.71 cents on the dollar, according to data compiled by Bloomberg...

Today’s gains add to a two-week rally that left Venezuelan bonds up 44.7 percent this year, the second-biggest return in emerging markets after the Ivory Coast. In his 14 years in office, Chavez has seized more than 1,000 companies and imposed currency and price controls as part of what he says is a push to turn South America’s biggest oil producer into a socialist country. Those moves left Venezuela’s yield premium to U.S. Treasuries over 1,000 basis points as recently as Oct. 10, according to JPMorgan Chase & Co.’s EMBI Global index.

“There is a clear correlation between the price of Venezuela’s debt and Chavez’s health,” Jorge Piedrahita, chief executive officer at Torino Capital LLC, said in a telephone interview on Dec. 6. “The market believes that a post-Chavez Venezuela will not be socialist.”

I do not doubt that Chavez's health is dire, but at the same time, I think market participants vastly overestimate the possibilities for change in the market-friendly direction. Certainly it won't happen all at once.