LATAM FX Talking: FX gains as risk appetite solidifies

Fiscal concerns are highest in Brazil, and much more modest in Mexico. But this difficulty in normalizing fiscal spending post-pandemic, and to bolster fiscal frameworks to return fiscal trajectories to a sustainable path, is playing out in most countries in the region, including in Chile, Peru and Colombia.

The 2021 outlook may also hinge on post-pandemic growth-trajectories, with noted upside for Brazil and Colombia. A constructive outlook for commodity prices should also benefit Andean FX in general, but political risk is high in Chile and Peru.

Overall, in this more benign environment from EM FX in general, and a weaker USD, we see greater scope for outperformance in Brazilian and Colombian assets. Mexican assets remain attractive, in our view, but the rally seen in recent months have brought local assets closer to fair value, in our view.

In particular, the COP and the BRL stand out in the region as the currencies with the strongest potential for appreciation in 2021. Even though the potential for appreciation appears largest in the BRL, the COP may offer the best risk-reward proposition.

Brazil’s fiscal outlook is much more challenging and less certain than Colombia’s, while we also see greater upside for Colombia’s oil-driven terms-of-trade than for Brazil’s more diversified export basket.

From a political risk point of view, Colombia also stands out as a safer alternative in LATAM, when considering the tumultuous 2021 electoral cycle projected for Peru and Chile, along with mid-term elections in Mexico and a very active Brazilian Congress that’s likely to keep headline risk elevated.