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By Rodrigo Campos and Marc Jones
July 2 (Reuters) - Colombia's markets slid on Friday but then recovered by late morning in volatile trading, a day after Fitch became the second major credit rating agency to downgrade the country's credit rating to 'junk'.
Investors expected the rating downgrade after a tax reform failed in Congress, leading to social unrest and costing the finance minister his job.
"Given the delay in the passage of reform the downgrade was expected by the market," said Shamaila Khan, head of EM debt strategies at AllianceBernstein in New York. "Though there may be some forced short term selling, it is mostly priced in."
The move from Fitch follows the loss of investment grade category at S&P Global in May. The country is now rated 'junk' by two of the world's top three rating agencies, potentially forcing some holders out of Colombian debt.
Five-year credit default swaps hit their highest since late May at 143 bps but paired back to 138 bps, up 1 bp on the day, while the Colombian peso softened as much as 0.6% to a two-month low before turning slightly positive, up less than 0.1%.
The local stock market fell as much as 1% in early trade but bounced back to a session high gain of 0.7%.
The premium demanded by investors to hold Colombia's debt over safe haven U.S. Treasuries hit its highest since early October 2020 and was last up 3 basis points (bps) at 253 bps.
With rising fiscal, political and social risk premiums, and a worsening inflation outlook, Colombia's central bank’s "degrees of freedom to preserve a high level of monetary accommodation have narrowed considerably," said in a note Alberto Ramos, Goldman Sachs' chief of economics for Latin America.
A downgrade from Moody's, which still has Colombia two notches into investment grade category, is widely expected. (Reporting by Marc Jones and Rodrigo Campos, writing by Karin Strohecker; Editing by Chizu Nomiyama and David Gregorio)