Weekly Latin America Risk Monitor

As usual, we’re keeping it brief. Email us at if you’d like to dialogue further on anything you see below. Also, we are always happy to forward along prior notes which may contain additional color on the specific topics/countries you see below.

 

THEME

Dovish monetary and fiscal policy talk (and action, in some cases) is dominating Latin America’s storylines.

 

PRICES

By and large, Latin American equity markets had a strong week, closing up +2.7% wk/wk and +3.2% wk/wk on an average and median basis, respectively. Recent moves and speculation around the future of monetary policy contributed heavily to the best/worst divergence: Brazil’s Bovespa Index was up +6% wk/wk on the heels of a -50bps rate cut vs. Argentina’s Merval Index closing down -0.4% wk/wk on currency devaluation speculation.

 

In Latin American FX markets, the -2.3% wk/wk decline in the Brazilian real (vs. the USD) led the way to the downside, also largely due to the “surprise” rate cut. Conversely, the Chilean peso put on a +1.3% wk/wk move vs. the USD largely due to the minutes of the central bank’s Aug. 18 meeting, which showed that Chilean policymakers consider it too early and too aggressive to cut interest rates in the near term.

 

In Latin American bond markets, Brazil’s interest rate cut stole the show, facilitating a wk/wk decline of -28bps in Brazil’s 2yr sovereign debt yield. The cut was, however, priced in to some extent, as yields fell just slightly over half of the full extent of the -50bps Selic Rate cut; if anything, Brazil’s bond market was signaling this for at least the last few weeks (2yr sovereign debt yields down -152bps MoM). Brazil’s on-shore interest rate swaps market had a more forceful reaction, with the 1yr tenor closing down -57bps wk/wk.

 

From a credit quality perspective, CDS broadly declined wk/wk throughout the region, with the suddenly moderate Peru (more on this below) leading the way to the downside on a percentage basis (down -25bps/-14.8%).

 

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KEY CALLOUTS

Brazil: If it’s not obvious, the key callout from the Brazilian economy last week was the Banco Sentral do Brazil’s decision to cut their benchmark Selic interest rate -50bps, citing a “generalized reduction of great magnitude in the growth projections of principal economic blocs” and “the [hawkish] outlook for [Brazilian] fiscal policy”. Interestingly, there is a great deal of talk surrounding how politicized this decision was, given the enormous amount of blunt pressure recently directed at the central bank by various members of the Brazilian government – including President Rousseff herself. We walk through this dynamic as well as the outlook for fiscal policy in 2012 in great detail in our 9/1 note titled, “Eye On Brazilian Policy: Oh No You Didn’t” (email us for a copy).

 

Elsewhere in the Brazilian economy, economic data continues to come in rather soft on the margin. Industrial production growth slowed in July to -0.3% YoY (vs. +1.1% prior); industry confidence ticked down in Aug. to 102.7 (vs. 105 prior); manufacturing PMI ticked down in Aug. to 46 (vs. 47.8 prior); capacity utilization ticked down in Aug. to 83.6% (vs. 84.1% prior); and trade balance growth slowed to +$1.5 billion YoY (vs. +$2.2 billion prior).

 

Chile: The key news out of Chile last week was that, unlike Brazil, the Central Bank of Chile considers it too early to cut interest rates. On the flip side, Finance Minister Filipe Larrain did say the government was “prepared to confront a drop in international demand”, suggesting that countercyclical fiscal policy is being readied in the event global growth slows further. Chile’s fiscal metrics are slightly positive (deficit at 4.5% of GDP; debt at 8.8% of GDP), so there is some headroom for Chilean policymakers to act as a buffer if needed.

 

The latest Chilean economic data would suggest that need is growing on the margin: industrial production growth slowed in July to +0.7% YoY (vs. +4% prior); industrial sales growth slowed in July to +2.4% YoY (vs. +2.6% prior); retail sales growth slowed in July to +9.6% YoY (vs. +12.5% prior); unemployment rate ticked up in July to 7.5% (vs. 7.2% prior); and total payrolls growth slowed in July to -37.4k MoM (vs. +38.8k prior).

 

Peru: This we know: growth is slowing – real GDP growth slowed in 2Q to +6.6% YoY (vs. +8.7% prior). This we didn’t: Ollanta Humala’s regime is governing from slightly left of the middle of the political spectrum. While it would be far-fetched for us to label the newly inaugurated Peruvian president as a moderate, we’d be remiss to label the direction of his economic policy as anything substantially left of the center – which is what he initially campaigned just a few months ago.

 

Perhaps the most left-leaning of all legislation he’s introduced this far is a draft of the 2012 budget, which was recently approved by the Peruvian Cabinet. Still, despite higher spending and higher taxes, the outline calls for a surplus as large as 1% of GDP, suggesting Humala isn’t recklessly Keyneisan when it comes to the government’s fiscal health. On the more economically liberal front, Humala’s government is seeking to pass legislation that would foster the creation of a deeper corporate credit market, exchange-traded funds, and a repurchase agreement marketplace. Additionally, the president looks to garner 1 billion soles ($370 million) worth of private sector investment in government infrastructure projects over the coming months. It’s clear that Humala and his economically liberal team of advisors are putting forth their best efforts to prevent the Peruvian economy from slipping into the pitfalls of socialism – something we happily tip our hats to.

 

As it relates to the direction of policy in the nearer term, Peruvian Central Bank President Julio Velarde said last week that the bank “stands ready to adjust their interest rate policy if the global economy worsens”. Peru, with a benchmark interest rate of 4.25%, is one of the many emerging market economies which have proactively hiked rates over the last year and have some dry gun powder to use in the event of an economic growth emergency. Peru’s Finance Ministry, led by Miguel Castilla, stated that it is also ready to chip in with a $5.6 billion contingency fund held at the central bank. We’re not sure if this fund intends to use excess FX reserves in a scheme similar to Argentina’s and Venezuela’s. If so, we find fault with this in that a) it’s hard to walk away once the spending spree begins; and b) it’s flat-out highly inflationary (unofficially, Argentine and, officially, Venezuelan CPI readings are both north of +25% YoY).

 

Argentina: Perhaps a major red flag and the key callout of the week for Argentina is that Argentinean deposit rates are climbing amid widespread declines in interest rates throughout the region. This is due to the phenomenon of Argentine investors/savers pulling pesos out of bank accounts and converting them into U.S. dollars, etc. amid record-breaking capital flight from the country. For reference, the 12.7% interest rate Argentine banks paid for 30-day deposits on Aug. 25 was indeed a two year high.

 

Elsewhere in the Argentine economy, Vice Presidential candidate and current Economy Minister Amado Boudou came out last week and confirmed that the country won’t accept an audit of its economic data and policies by the IMF, which typically does so annually with each of its member countries via its Article IV consultation. Reading between the lines, this is essentially the Argentine government admitting that the country’s official growth and inflation statistics – which have been widely disputed since the late President Nestor Kirchner replaced Indec employees with political appointees in 2007 – are,  in fact, subject to faulty reporting. This is something to keep in mind ahead of current President Cristina Fernandez de Kirchner’s likely second term and what the impact on actual (vs. reported) inflation would be in the event she pursues a meaningful currency devaluation.

 

Darius Dale

Analyst


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