Date: 18-08-2015
Source: The Wall Street Journal
Mexican peso has declined as investors await U.S. interest-rate increase
Currencies in major Latin American countries are tumbling in the face of falling commodity prices, a sluggish growth outlook in China and fears of an imminent rate increase by the Federal Reserve.
This year, the Colombian peso has lost 21% of its value against the dollar, hitting a record low, while the Chilean peso and Mexican peso have depreciated by 12% and 10%, respectively.
Latin America has been at the forefront of a global selloff in emerging markets ahead of an expected increase in U.S. interest rates as the American economy improves. With rates low in the U.S., investors had flocked to emerging markets, where yields were higher and assets denominated in foreign currencies held out the promise of potential profits.
Many economies in the region also rely heavily on exports of commodities, and, therefore, the economic strength of China, which in recent years has been a big consumer of commodities. The latest bout of currency weakness was in part triggered by last week’s devaluation of the Chinese currency. A cheaper yuan would hurt China’s purchasing power for commodities produced in Latin America, such as copper and oil.
China is the biggest consumer of Chile’s copper, while Colombia and Mexico ship a significant amount of crude oil to China. On Monday, prices of copper and oil futures both fell to six-year lows on fears of weaker Chinese growth.
“These headwinds have really concentrated on Latin American currencies,” said Nick Verdi, a foreign-exchange strategist at Standard Chartered Bank in New York.
Emerging-market currencies, as a whole, have been losing value as the dollar has rallied this year. Weakening economic growth in the world’s developing countries, coupled with the prospect of higher U.S. interest rates, has put downward pressure on the currencies.
Due to the lack of growth and the central banks’ easy monetary-policy stances, these currencies will remain under pressure as the Fed approaches its first rate increase, analysts say. “What we need to stabilize the currencies is growth [in the region], and after growth, a tightening cycle. But the earliest [we can get it] is probably sometime next year,” said Siobhan Morden, head of Latin America strategy at investment bank Jefferies & Co. in New York.
Some analysts say the weaker currencies are also a result of heightened investor interest in Latin America. Some long-term investors have bought up Latin American stocks and bonds amid the recent slump, and, at the same time, have made bearish bets against those currencies as a way to hedge the potential downside risk. These hedges put downward pressure on the currencies.
“You have a lot of foreign investors, even local investors, hedging the currency exposure, which gives you a second round of weakness in the currencies,” said Mario Castro, a Latin America strategist with Nomura Securities.
During the first seven months of the year, Latin America was the largest recipient of investment flows among all emerging-market regions, eclipsing emerging Asia, according to the Institute of International Finance. In total, foreign investors purchased a net $62.9 billion in equities and bonds in Latin American countries, compared with $57.8 billion for Asia.
Within the region, Chile and Mexico stood out as investors’ favorites.
In Chile, investors have been comforted by the country’s political stability and low debt burden, thanks to years of fiscal discipline. The government is also able to tap a stabilization fund accumulated during years of high commodity prices to help the economy. Standard & Poor’s Ratings Services says Chile had saved about 12% of its gross domestic product as of June 2015. In July, Chile saw an inflow of about $4.5 billion, according to Scotiabank.
A recent report by S&P says the Chilean government’s net debt will probably stay low despite plans for more international issuance. It expects the net debt level to remain below 7% of GDP over the next three years.
Investors have been watching Chile’s President Michelle Bachelet’s recent reforms, which have hurt business confidence. The reforms include increased taxes to pay for an education overhaul, as well as plans to strengthen unions and make changes to the constitution.
For Mexico, investors are betting on its exporting sector to benefit from a rebounding U.S. economy, due to the close trade ties between the countries. Meanwhile, spreads between Mexican government bonds and U.S. Treasurys remain attractive, with the spread on the yield on the 10-year bond at 3.83 percentage points over comparable U.S. bond yields, compared with 3.6 percentage points at the beginning of July, according to Banco Santander.
Flows into Mexican peso bonds continued last month, although “it will undoubtedly be important to watch in the coming weeks the behavior of foreign investors given the possible interest rate increase by the Federal Reserve in September,” said Banco Santander in a report.
Investor flows into Mexican bonds and stocks have turned positive since May. As of July 28, foreign holdings of Mexican fixed-rate government peso bonds stood around $91 billion, accounting for 60% of the total in circulation, according to the Mexican central bank.
“Investors don’t seem to be broadly fleeing LATAM,” wrote Eduardo Suarez, co-head of Latin America strategy at Scotiabank, adding that he expects the currencies to bounce back once the Fed pulls the trigger on its first increase and the currency hedges are unwound.
On Monday, the U.S. dollar was fetching 691 Chilean pesos, 3001 Colombian pesos, which is a record low, and 16.43 Mexican pesos.
