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#55 - A Balancing Act: Navigating Diverse Fortunes of Latin American Currencies in 2023

Key Latin American currencies have experienced mixed fortunes so far in 2023. While MXN, COP and BRL all appreciated strongly vs the US dollar, the Peruvian sol has remained almost unchanged year-to-date (YTD) and the chilean peso declined by 4.3%. All this in the wake of weaker Asian currencies and especially a weaker renminbi.

What is behind the divergence?

After the sharp rebound following the pandemic, Latin Amerian central banks were the first to begin contractionary monetary policy. Eg. the policy rate rose from 2% to 13.75% in Brazil and from 1.75% to 13.25% in Colombia. Now that inflation is mostly under control and normalizing, central banks are expected to ease again. In fact, Chile, Brazil and Peru started easing recently.

Reasons for further monetary easing are convincing. First, inflation has come down sharply in the region. With the exception of Colombia, inflation is now at 5% or lower. On the one hand, inflation is slowing down due to stabilizing commodity prices and resolving supply chain disruptions, on the other hand due to slowing consumer and business confidence amid political uncertainty.

Second, China - the biggest export partner of the region - is struggling to regain its former economic strength. This struggle stems from a combination of deteriorating demographics, supply chain relocations amidst geopolitical shifts, and a transition in the growth model from investment-driven to consumption-driven.

After disappointing growth following the reopening so far in 2023, the IMF has taken down its growth forecast for this year to 5% and for the following years to decline from 4.2% in 2024 to 3.4% in 2028.

This may have profound implications for the Latin American economies given the high dependence on exports to China. Countries in the region supply vital commodities to China, while China has developed into an important trading and financial partner. According to the World Bank total trade between Latin America and China has increased more than 25-fold between 2000 and 2022. China is now the largest trading partner for Chile, Peru and Brazil.

If Chile, Peru and Brazil have the highest export share with China, why the difference in performance or CLP, PEN and BRL? The answer lies partly in what is exported to China. While Brazil is the main supplier of soybeans to China with exports reaching over 50mln tons in 2022, Chile and Peru export mostly Copper to China. Copper makes 54% of Chile's exports to China and 61% or Peru's. The mix for Brazil is more favorable as soybeans only make up 32% of total exports to China.

Why do Latin American central banks do not cut rates more agressively?

The divergent economic paths of the US and China present a complex challenge for decision-makers in Latin America. Latin American economies are dependent on both for trade and investement. While China's current economic malaise may be a reason to cut rates faster, high interest rates in the US are a hurdle as it directly impacts capital flows, the exchange rate and inflation. Hence, central banks of the region are faced with the elevated difficulty of balancing the slowing economic activity due to high real policy rates and not undermining its inflation goals when cutting rates to quickly leads to weaker exchange rates and a rebound in inflation. Bottom Line:

Latin American currencies had on average a strong year versus the USD but huge divergence under the hood. COP, MXN and BRL all rallied sharply on high carry, strong fixed income performance and a favorbale export mix. Chile and Peru lagged in foreign exchange performance given its huge dependence on copper exports, a key input for China's construction sector. Latin America's central banks now face the dilemma of diverging US and China economies. While Mexico and Colombia benefited from the closer ties to US, Chile and Peru are impacted by the slowing real estate sector in China. If the US slows down into next year - as we expect - the fortunes may change. The outlook for China, however, remains a key drag on the region.


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