LATAM: Contrasting Views of Fixed Income and FX Investors

The coronavirus pandemic has disrupted economies worldwide, including the United States, albeit in varying degrees. GDP contracted across Latin America, with Chile, Colombia and Mexico being hit harder than Brazil, or for that matter, the U.S.  Although Brazil’s economic activity didn’t fall as much as some of its neighbors, it has been the laggard in the wake of its 2015-16 recession (Figure 1).

Figure 1: The pandemic disrupted economies across the Americas in 2020

All four of the free-floating LATAM currencies (of Brazil, Mexico, Chile and Colombia) fell sharply versus the U.S. dollar in the early stages of the pandemic.  Since then, the Mexican peso (MXN), Chilean peso (CLP) and Colombian peso (COP) have rebounded.  The Brazilian real (BRL) remains weak (Figure 2).

Figure 2: Chilean, Colombian and Mexican currencies have rebound versus USD

Among these four nations, Mexico is the odd man out.  Brazil, Chile and Colombia rely heavily on exports of natural resources (Figures 3-5).  Mexico’s economy depends heavily on manufacturing exports and tourism (Figure 6).  While the tourism sector has been hard hit by the pandemic, Mexico’s manufacturing sector has boomed as companies look to diversify supply lines away from China in the wake of the Sino-U.S. trade dispute. 

Figure 3: Brazil’s exports are weighted towards industrial metals and agricultural goods

Figure 4: Copper accounts for nearly half of Chile’s exports

Figure 5: Crude oil, coal and agricultural goods dominate Colombia’s exports

Figure 6: Mexico’s exports are overwhelmingly manufactured goods

Normally, their currencies closely track indices of commodity prices weighted to reflect their importance to each country’s exports.  The Chilean and Colombian pesos have underperformed the dollar value of their commodity exports, but both currencies rebounded somewhat as energy and metals prices headed higher (Figures 7 and 8).  This was not the case in Brazil (Figure 9).  Brazil suffered pandemic-related mining shutdowns, which prevented the country from fully benefitting from higher metals prices.  Moreover, a severe drought hit the agricultural sector in Brazil and Argentina in the third and fourth quarters of 2020, reducing the output of soybeans and corn. The drought rallied prices for both crops, but economic gains were tempered by the reduced production, leaving BLR in the doldrums. 

Figure 7: COVID-19 has kept CLP from rallying with commodity prices

Figure 8: The pandemic has also prevented COP from rallying as much as Colombia’s export prices

Figure 9: Mining shutdowns and drought helped BRL to diverge from commodity prices

Investors in the currency markets seem to see Brazil remaining as the weakest economy of the region, with Mexico expected to be the strongest.

As we begin 2021, investors in interest rate markets are seemingly becoming much more optimistic regarding future economic growth.  The U.S. Treasury yield curve has steepened sharply in recent weeks, reflecting investors’ confidence and hope in vaccines releasing pent-up demand, and the possibility of additional fiscal stimulus by the incoming Administration.

Yield curves in Latin America began steepening this past summer as LATAM central banks slashed interest rates to record lows across the region.  Currently, Brazil has one of its steepest yield curves ever observed, Chile’s yield curve is at its steepest since 2010 and Colombia’s is at its steepest since 2013. The Mexican yield curve has also steepened, although it is not particularly steep historically (Figure 10).

Figure 10: Yields curves are more optimistic for Latin America, especially for Brazil

In the past 15 years, yield-curve slopes have correlated positively with future economic growth. As such, the advent of more positively sloped yield curves might be a harbinger of a strong economic recovery to come, especially in Brazil, Chile and Colombia and to a lesser extent in Mexico (Figure 11).

Figure 11: LATAM yield curves correlated positively with future growth in real GDP from 2005-19

Latin American yield curves steepened largely in response to central banks slashing interest rates across the region (Figures 12-15.)  Lower short-term borrowing costs could help businesses to rediscover their Keynesian ‘animal spirits’ and also boost consumer spending while lowering the cost of financing existing debt for governments and other entities.  So long as inflation remains remain low, central banks could also keep borrowing costs low.  The risk of higher rates may well be highest in Brazil, where borrowing costs are now below the rate of inflation and where the currency remains weak. By contrast, a stronger Mexican peso could possibly keep a lid on the country’s inflation rate, allowing rates to stay lower for longer.

Figure 12: So long as Mexico’s core inflation rates doesn’t rise, Bank of Mexico can keep rates low

Figure 13: Brazil’s short-term interest rates are now negative in real terms

Figure 14: Banco Central de Chile has record low policy rates

Figure 15: Colombia’s policy and inflation rates have plunged during the pandemic

Bottom Line

  • Central banks have slashed rates across Latin American, steepening yield curves
  • Steeper yield curves have normally correlated to stronger future GDP growth
  • Brazil has the weakest currency, but the most optimistic yield curve
  • Mexico has the strongest currency and the least optimistic yield curve
  • Inflation rates remain low in Latin America for the moment
  • Mexico’s industrial exports set its economy apart from natural resourced-based exports in the other countries

 

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

About the Author

Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.

View more reports from Erik Norland, Executive Director and Senior Economist of CME Group.

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