By Erik Norland
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).
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).
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.
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.
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).
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).
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.
- 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
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