Turbulent Year Ahead for Latin American Currencies

The year ahead is likely to be a turbulent one for Latin American currencies. The first inklings of this came when the U.S. Federal Reserve announced plans to …

The year ahead is likely to be a turbulent one for Latin American currencies. The first inklings of this came when the U.S. Federal Reserve announced plans to wind down its bond-buying program known as quantitative easing, or QE. During the “taper tantrum” of 2013, panicky investors sold off risky assets in Brazil, Mexico, Colombia, and other markets in order to get a higher return on investments in sovereign debt in the United States.

Initially, 2014 proved something of a respite for Latin American currencies, as mixed economic data in the U.S. and the fragility of the global economy led the Fed to keep the interest rates at near zero.

Oil prices stayed above $90 a barrel, a key source of stability given that the commodity is the region’s chief export and a major generator of dollars. Yet, the Fed’s termination of QE in October, coupled with the dramatic drop in oil prices, has seen Latin American currencies lose much of their value against the dollar.

Devalued currency supports export of goods and services. This is the logic behind Japan’s current easy money program known as Abenomics. But swift currency depreciations can jolt businesses that pay for goods in dollars, and stoke inflation, scare away foreign debt investors, most of them interpret a weakening currency as a sign of larger economic problem.

Brazil’s Real

Brazil’s real has dropped about 6% so far in December, and now it is at its lowest level, 2.76 per dollar, in almost a decade. There are many factors affecting Brazil’s real, including the alleged corruption scandal in Petrobras.

Even the Colombian currency has been hit hard despite the country’s solid GDP growth, moderate inflation, and sound macroeconomic management. Since July, the Colombian peso has lost more than 25% of its value against the dollar, the deepest slide of any major currency except the Russian ruble.

The Mexican peso’s decline has been just slightly more gradual. Many forecasters now predict that in 2015 the Mexican currency could reach its all-time low against the dollar.  Unlike many other currencies, the buying power of the Mexican peso matters to small businesses in the U.S.

Retailers in the border towns of Texas and Arizona are worried that fewer Mexicans will do their holiday shopping north of the border, or be visiting to buy goods next year. “They’re spending money,” Felipe Garcia, executive vice president of Visit Tucson, told Arizona Public Media earlier this week: “The only thing we’re seeing is that they’re doing so in shorter trips. If (Mexican visitors) were going to stay two nights, they’re staying just one night. If they were coming for one night, maybe they’re just coming back and forth on the same day.”

It is possible that 2015 could see investors pull out of foreign markets en masse, spreading the contagion from Russia to Latin America. The 1998-1999 Asian financial crisis could repeat itself.

A more probable scenario involves temporary spikes in exchange rates in response to Fed statements and rate hikes. Of course, peso values could stabilize as well, especially if the Bank of Japan and the European Central Bank add to global liquidity by ramping up their own quantitative easing programs. Here again, though, Latin American currencies will be driven more by global forces than domestic economic realities.

Crucially, even in cases where the region’s major currencies weaken, those movements are likely to spur benefits down the line. For example, although Mexican tourist spending in U.S. border states may decline as a result of peso weakness, Mexican goods will become cheaper, making themselves more attractive for export.

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Moreover, central banks in many countries have become mute spectators of currency fluctuation. So far, this has been the case with Mexico and Colombia, both of which enjoy world-class central bank managers.

If peso continues to stoke inflation, central banks in both the countries may move to raise rates.  Low inflation and positive economic outlook strengthen their hands, leaving them ample room for adjusting rates.

 

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