LATAM FX Talking: FX gains lose steam as correction takes hold
After ending 2020 with a firmly bullish momentum, LATAM FX markets are correcting, largely in reaction to rising US Treasury yields and the stronger USD. We don’t expect this trend to last. In that case, we see greater scope for outperformance in Brazilian and Colombian assets, while Mexican assets remain attractive but seem nearer fair value, in our view.
Executive summary
Despite improved prospects for additional fiscal stimulus measures in the US, soft activity data, weighed down by the still-rising Covid-19 spread, should prevent any near-term change in the US Fed’s policy guidance, which should help re-ignite the USD-weakness trend.
The vaccine-fuelled global recovery should, meanwhile, help revive risk appetite and benefit EM assets in general. This suggests that, despite lingering concerns, notably the fiscal weakness seen throughout LATAM, we consider that attractive valuations, higher commodity prices and a faster recovery, as the region avoids additional lockdowns, bode well for a constructive 2021 for local assets in LATAM.
Fiscal concerns are likely to remain elevated in the region throughout 2021, following the sharp deterioration suffered during the pandemic. 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.
Appetite for local assets 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.
Lastly, monetary policy could turn into another important catalyst for relative FX performance. Here the focus will be on Brazil and Mexico, with the bias pointing towards a sooner-than-previously-expected rate-hiking cycle in Brazil and a deeper-than-expected rate-cutting cycle in Mexico. Monetary policy has been, arguably, the most important domestic driver for the strength of the Mexican peso versus the Brazilian real in recent quarters. And as the policy rate rises in Brazil while falling in Mexico, the balance-of-risks should become more supportive of the BRL, in relation to the MXN.
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