As usual, we’re keeping it brief. Email us at if you’d like to dialogue further on anything you see below.
Growth continues to slow in Latin America while recent and future policy actions are creating some obvious warnings signs in the system – particularly as it relates to the FX exposure of investors and corporations alike.
Last week was rough week for Latin American equity markets, closing down -2.2% wk/wk on average. We did see the larger markets like Brazil’s Bovespa Index and Mexico’s IPC Index outperform the smaller, more illiquid markets like Argentina’s Merval Index and Colombia’s IGBC General Index, with the notable exception of Venezuela’s Stock Market Index (up +51.4% YTD). In Latin American FX markets, currencies broadly appreciated vs. the USD wk/wk, with the exception of the Argentinean peso (ARS) who’s -0.5% wk/wk decline echoes a developing trend of capital flight from the country.
The big callout in Latin American fixed income markets is the -50bps wk/wk decline in Brazilian 2yr sovereign debt yields as expectations for future interest rate cuts continue to get priced into Brazil’s interest rate market (1yr on-shore swap rates declined -37bps wk/wk and -95bps MoM). Interestingly, Friday’s closing yield of 11.54% is a full 96bps below the Brazilian central bank’s benchmark interest rate (the Selic), currently at 12.5%. In Latin American CDS markets, the key callout is the +10bps backup in Argentina’s 5yr swaps amid broad-based declines throughout the region.
Brazil: Last week was a busy week for Latin America’s largest economy. Early in the week, it was reported by O Globo that the external debt for large Brazilian corporations had increased +74% from 3Q08 levels. We continue to flag the external debt buildup of many emerging-market economies over the last ~2 years as an incremental risk for some emerging market equities heading into an environment of slower global growth – particularly if the dollar continues to strengthen against EM currencies (a lower exchange rate increases their nominal debt burden). The Brazilian real in particular is down -2.3% vs. the USD over the last month, in part due to the latest 1% tax on FX derivatives (imposed on July 27). Anecdotally, the latest measure has been said to have increased volatility in Brazil’s on-shore FX derivatives market as well as reduced corporate incentive to hedge the FX risk.
Elsewhere in the Brazilian economy, we see signs that Brazil is headed in the wrong direction from a fiscal policy/regulatory perspective per the roadmap we outlined in our recent deep dive on the Brazilian economy (email us if you’d like a copy). First, it was reported by Miriam Leitao that president Rousseff vetoed proposed legislation that contained a balanced budget proposal, as well as other legislation that would have added transparency to the Treasury’s dealings with BNDES – both supportive of higher rates of inflation over the long-term TAIL as the government rejects fiscal discipline on the margin. Secondly, the government added yet another layer to the Brazilian bureaucracy by creating the National Commission of Airport Authorities – a move we see as negative on the margin for the expediency of getting the country’s airport infrastructure up to speed in time for the 2014 World Cup. Lastly, it was leaked to Brazilian newspaper Valor Economico that the government was considering reducing its primary surplus in 2012 – a negative development for the necessary positive adjustment to Brazil’s gross national savings rate in light of the country’s infrastructure initiatives over the next 2-3 years.
From an economic data perspective, Brazilian growth continued to slow with registered job creation slowing to +140.6k MoM in July and the Economic Activity Index (proxy for GDP) slowing in June to +2.9% YoY and -0.26% MoM – the first MoM decline since December 2008! We remain bearish on Brazilian equities for the intermediate-term TREND as growth continues to slow and inflation remains sticky.
Mexico: The key callout as it relates to Mexico last week was a slowing 2Q GDP print of +3.3% YoY (vs. a prior reading of +4.6%). Moreover, the Global Economic Indicator Index (a proxy for GDP) slowed in June to +3.6% YoY (vs. a prior reading of +4.6%). The late-quarter slowdown highlights a key point we’ve been aggressively making since March – the slowdown in global growth is not merely a function of Japan’s earthquake/tsunami.
Mexico’s Ministry of Finance believes the country is likely to expand +4% YoY in 2011 and, while accelerating same store sales growth (+6.4% YoY in July) remains supportive of Mexico’s consumer story, our models continue to point to a full-year GDP growth rate roughly 100bps shy of those expectations. Net-net, we remain the bears on Mexican equities for the intermediate-term TREND as growth slows and the bears on the Mexican peso (MXN) over the same duration as said economic slowdown causes Banco de Mexico president Ron Carstens to continue with Indefinitely Dovish policy well into 2012 as TIIE futures are indicating.
Chile: Another country, another growth slowdown; 2Q GDP growth slowed from +9.9% YoY to +6.8% YoY. Our models point to Chilean economic growth continuing to slow in 2H (though to rates just shy of current levels), and, apparently, so do the central bank’s. Last week they held their benchmark interest rate flat at 5.25%, marking their third pause YTD. In the monetary policy announcement, board members dropped previous mention of possibly raising borrowing costs in the future, citing “the implications of internal and external macroeconomic conditions”.
Like us and the Chilean central bank, the country’s Ministry of Finance is also modeling in a continuation of the current slowdown in Chilean economic growth in 2H. Finance Minster Felipe Larrain is on record saying, “Chile’s economic growth, as well as consumption and investment levels will decelerate in the second half of the year after a solid first-half expansion.” We remain the bears on Chilean equities for the intermediate-term TREND.
Colombia: Like Brazil, Colombia screened poorly in our (growing) external debt monitor. In fact, it was reported last week that Colombian corporations have borrowed externally at a record pace YTD, growing the stock of external debt by a +$1.1B YoY in just the first seven months alone! For a sense of the magnitude, this is on top of a mere -$184M decline in full-year 2010. As with most emerging markets, the gaping interest rate differentials between on-shore paper (4.5% benchmark lending rate) and US dollar/euro/yen denominated paper is driving Colombian debtors abroad.
Both Colombia’s central bank and Ministry of Finance are griping about the “rising dollar inflows” putting upward pressure on Colombia’s exchange rate and we believe interventionist measures, like the deposit scheme of 2007, are on the policy debate table in the coming weeks. Colombian President Juan Manuel Santos explicitly agrees, saying last week that, “Latin American governments must intervene in [FX] markets to correct any failures… authorities can’t take a passive approach to currency appreciation that diminishes the competitiveness of exporters.” Holders of the Colombian peso, peso-denominate assets, and highly-levered Colombian equities beware.
Argentina: The key callouts out of Argentina last week centered on President Fernandez’s sweeping victory in the Argentinean primary election and capital flight/currency devaluation. To the first point, Christina Fernandez garnered just over 50% of the votes while the closest opposition candidate came away with just over 12% apiece – all but ensuring she’ll win a second term as president in upcoming election on the 23rd of October. Her victory is leading some to believe that she’ll purse a more expedient form of currency devaluation upon re-taking office. This is due to the likelihood that Argentina’s “free and available reserves” (FX reserves less monetary base/M0) shrinks to ~$4.7B by year-end (down -65.6% YoY). This is important because Argentina, like Venezuela, favors using FX reserves to fund government expenditures, like the repayment of external debt, for instance.
A currency devaluation would increase the convertible value of Argentina’s “free and available reserves” and give the Argentinean government some wiggle room to continue servicing restructured debt and potentially pursuing expansionary fiscal policy in 2012. The central bank is held hostage from lowering interest rates to support the economy (in the event it becomes necessary) due to the record pace of capital flight (-$9.8B YTD vs. -$11.4B in all of 2010) and elevated rates of consumer price inflation, which Argentinean consumers and private economists believe to be around +25% YoY (vs. the government’s officially-tainted report of +9.7% YoY).
Venezuela: The major news out Venezuela last week that is relevant on a Global Macro basis is ailing president Hugo Chavez’s decision to nationalize Venezuela’s gold mining industry. He also announced that Venezuela plans to repatriate $11B of gold assets held abroad in a scheme designed to shift Venezuela’s liquid reserves to “allied countries” (including itself, China, Russia, and Brazil). The key callout here is that you typically see aggressive maneuvers like this near the peak of bubbles – something gold investors must become increasingly cognizant of.