Weekly Latin America Risk Monitor: Market Likes Socialism

Conclusion: Last week equity investors bid up the socialist economic policies of Venezuelan president Hugo Chavez and Peruvian president Ollanta Humala. Moreover, the BRL’s negative divergence calls attention to a longer-term issue for the Brazilian economy.


This is the second installment of our now-weekly recap of prices, economic data, and key policy action throughout Latin America. We’re aiming to keep our prose tight here, so if you’d like to dialogue more deeply regarding anything you see below, please reach out to us at .




Week-over-week, the equity markets voted “yes” for the socialist economic policies of Venezuelan president Hugo Chavez (Venezuela Stock Market Index +5.8%) and newly-elected Peruvian president Ollanta Humala (Lima General Index +2.2%). We used the strength in Peruvian equities to short the EPU in our Virtual Portfolio. In the FX market, the Brazilian real (BRL) brought up the rear (-0.9% wk/wk), largely due to the newly imposed capital controls introduced by the central bank (see details below). From a credit perspective, CDS spreads widened on a regional basis with Colombia leading the way from a percentage change perspective. On major callout from our cross-asset-class correlation analysis is the incredibly high positive correlation  developing between the MSCI Latin American Equity Index and the US 10yr Treasury Note (r² = 0.92 on a 3wk basis).


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Brazil: Central bank president Alexandre Tombini iterated that it would take “six to nine months” for the “full effect” of their tightening to be felt. It’s clear the Bovespa (-14.2% YTD) is pricing this slowdown in growth over the next 2-3 quarters. Last weekend (7/9-7/10), the central bank dramatically increased reserve requirements for Brazilian banks’ short-dollar positions. The move is designed to reduce the Brazilian banking system’s net short exposure the USD by a third. On a long-term TAIL basis, we are concerned that the central government’s intervention in the FX market will limit the country’s growth relative to consensus expectations. Simply put, at 16.5% of GDP, Brazil doesn’t save enough gross national savings to account for the large projected acceleration in fixed capital formation over the next 3-5 years.


Mexico: It was a great week for Mexico from a economic data standpoint; April Gross Fixed Investment growth accelerated to +7.2% YoY, May Industrial Production growth accelerated to +4.6% on a YoY basis and +1.1% on a MoM basis, and June ANTAD Same-Store Sales growth came in much faster at +4.2% YoY (vs. -0.9% prior). Central bank governor Ron Carstens has shown his Keynesian resolve over the last three years by keeping Mexico’s benchmark interest rate at an all-time low and we believe market expectations for tighter monetary policy will continue to be extended into the future as Mexican CPI fails to breach the central bank’s  full-year 2011 target of 4%.


Chile: Despite June CPI sequentially accelerating to +3.4% YoY, the Chilean central bank used “signs of moderation” in domestic output, demand, and its labor market to hold its benchmark interest rate flat at +5.25%. This is counter to what the central government is seeing, as evidenced by them raising their 2011 GDP growth forecast +50bps to 6.6%. Our models put us closer to the central bank, and we expect to see a protracted slowdown in the rate of Chile’s YoY GDP growth in the quarters ahead. Look for that to weigh on its currency, the Chilean peso (CLP), which has been Latin America’s best performer over the last year (+15.9%). On the flip side, a bullish breakout in copper prices supported by a positive reevaluation of Chinese demand is (CLP/copper positive correlation: r² = .90 on a 3wk basis) is incrementally supportive of the CLP.


Peru: Aside from the move we made in our Virtual Portfolio on Friday (short EPU), the key callout from Peru this week is that its monthly Real GDP index slowed in May to +0.5%, which was the slowest MoM growth rate in over a year. Weak business investment (perhaps due to the uncertainty surrounding June’s presidential election) is cited as a culprit for the slowdown. Given that the business-unfriendly Ollanta Humala did indeed win, we expect to see further weakness here over the intermediate term as Peruvian corporations take a wait-and-see approach towards Humala’s economic policy. We expect foreign investors to do the same, and we expect Humala to eventually reveal himself as the far-left-leaning socialist the market ascribes him to be.


Argentina: The Argentinean government filed criminal charges against an independent research firm for reporting “false” inflation statistics. Further, the IMF gave the country a 180-day ultimatum to dramatically improve the quality of its economic data, which many believe to drastically understate CPI and overstate GDP. Should the Argentinean government fail to comply with the deadline, a soft threat of “necessary measures” was issued. We believe all countries make up the numbers to some extent, but Argentina is widely considered the poster-child in this regard.


Venezuela: Ailing president Hugo Chavez continued on his socialist, inflationary bend, this time forcing the central bank to transfer another $1.5B of international FX reserves to an off-budget development fund designed to finance infrastructure investment. This would take the YTD total amount injected into the “Fonden Development Fund” to $3.5B and the lifetime total north of $40B (since 2005). It’s not surprising to see that such injections have had a profound impact on Venezuela’s CPI, currently running over +25% YoY. Still, Chavez plays ignorant, saying alongside the announcement, “In the past, the central bank didn’t want to give resources to the government, [and] they refused citing inflation and using monetary stability as an excuse. It was the IMF running things. Now we’re free. That’s independence.” Perhaps “independence” is Venezuelan code for “inflation”.


Darius Dale


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