LATAM FX Talking: FX gains amid tentative rise in risk appetite

This more constructive environment for LATAM FX would be justified as a catch-up to the sharp USD correction seen in recent months, the ongoing uptrend in commodity prices, growing evidence that the Covid-19 spread is subsiding throughout the region and, lastly, evidence that economic activity is recovering a bit faster than previously expected, notably in Brazil and Chile.

Scope for additional appreciation in local assets is still substantial in some places that have been especially affected by selloff, notably Brazil, but LATAM’s post-Covid macro outlook looks remarkably challenging.

The region will suffer a deep GDP contraction and a massive deterioration in fiscal metrics, demanding from local governments credible post-pandemic economic recovery plans that also manage to return fiscal accounts to a long-term sustainable path. As seen in Brazil in recent weeks, political pressure to keep fiscal spending elevated beyond 2020 may generate frequent episodes of market volatility, as governments decide how to balance fiscal responsibility and the need to support domestic demand.

With practically no scope left to stimulate demand through rate cuts, apart from Mexico where the policy rate remains close to “neutral” territory, pressure to stretch fiscal stimulus or delay the inevitable fiscal correction should be intense throughout the region, often resulting in the appearance of fiscal populism and market noise. In fact, the recession and the fiscal deterioration should weigh heavily on the outlook for credit-ratings throughout the region, with the threat of loss in investment grade affecting many corporate and sovereign credits in the region, notably in Mexico and Colombia.