LATAM FX Talking: A benign interlude
Even though trade-related risk aversion remains a key driver for LATAM FX, the USD has become the chief catalyst for most currencies in the region. We see more downside for the USD early next year and if this benign market assessment continues, it would benefit LATAM currencies (COP and BRL) that are more sensitive to external drivers and risk aversion
Executive summary
The BRL has benefited in recent days from the USD weakness resulting in an outperformance after a long stretch of underperformance. Even though we remain especially bullish on the BRL in the longer term, the currency’s short-term prospect remains weighed down by stronger-than-expected FX outflows. Low domestic rates have contributed to FX instability by incentivizing large-scale FX outflows, as corporates replace external funding with newly available low-cost local funding. As CB officials have highlighted, this should continue to exacerbate FX outflows and add a persistent near-term weakening bias for the BRL. And, for the currency to outperform, and consolidate below 4.0, those outflows must be offset by inflows, which should only rise when domestic activity data strengthen materially, which may happen only gradually.
In Mexico, high local rates should continue to play a critical role in the stabilization of the MXN. In fact, thanks to Banxico’s policy strategy, the Mexican peso has been a consistent outperformer since Andres Manuel Lopez Obrador’s election on 1 July 2018. Our expectation is for Banxico to continue to follow the US Fed’s lead in the very near term. But the risk of a more frontloaded cycle has increased, amid the sharp growth deceleration, and this scenario should consolidate if the MXN remains stable.
Argentina’s assets have been supported by assertive monetary policies but, should the 27 October presidential election confirm that Alberto Fernandez will be Argentina’s next president, episodes of extreme volatility should resurface. Given Fernandez’s unorthodox economic policy credentials, his ability to roll over debt amortizations should be further debilitated. A debt default is not inevitable, but it would likely require a considerable policy tightening (ie, stronger fiscal balances, high interest rates and a strong ARS) and that seems, arguably, unrealistic to expect from Fernandez.
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