After a short-term rally following the breakout of the Ukraine conflict, most LATAM currencies are back where they started
We expect LATAM will continue to experience high FX volatility as US interest rates rise, China’s growth prospects weaken, and the domestic outlook remains moderate relative to historical trends. Moreover, firms should expect a continuation of interest rate hikes across markets, as a stronger dollar will also squeeze policymakers to defend their currencies or risk importing even more inflation.
Overview
While the war between Russia and Ukraine added new complexities to LATAM’s operating environment, the region benefited from new capital inflows as investors reshuffled investments into other emerging markets that would benefit from high commodity prices. Consequently, this capital reallocation led many LATAM currencies to appreciate. However, this appreciation was short-lived due to this capital’s highly speculative nature. The growing expectation of consecutive interest rate hikes by the US Federal Reserve has driven much of these investments to migrate from Latin America to safer markets in the last two weeks. Additionally, weakening Chinese growth prospects due to the ongoing “zero COVID” strategy will also weigh on LATAM currencies. Among the top-tier markets, Peru and Brazil are the only currencies that continue feeling a net appreciation since the start of the conflict. On the other hand, Colombia and Mexico have essentially returned to their pre-currency valuations, and Chile’s spot rate remains depreciated vis-à-vis its valuation at the start of the conflict.
Our View
The Ukraine conflict and the subsequent Western sanctions caused world commodity prices to rise. For emerging countries that depend heavily on commodity exports, this rise in prices made their currencies recover their value, especially those of Latin America. However, we ultimately expect these appreciating forces to be short-lived. The continuity of the “zero COVID” policy in China will inflict new supply chain closures and bottlenecks at the international level in the trade environment, which will drive down commodity prices, negatively impacting emerging-market currencies. Additionally, monetary policy in advanced economies is expected to tighten, triggering an aversion to risk and preference to the dollar and weakening emerging-market currencies. Ultimately, Latin America will be a mixed bag of appreciating and depreciating currencies relative to 2021; we expect Brazil, Peru, and Mexico to have stronger currencies, while Chile, Colombia, and Argentina will have a weaker FX position.
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