Acronyms serve a purpose that, in finance at least, often outlives the original rationale for their existence. This certainly holds true for the BRIC (Brazil Russia India China), designed to group the major fast growing emerging markets of the last decade. Russia was the weak link in the early part of the financial crisis (thanks to falling oil price), but Brazil has taken up that mantle in more recent years. Russia can partially blame oil, but Brazil’s problems have been largely of their own making, including weak investment, poor structural reforms, together with stubbornly high inflation.
There have been three broad themes in Latam currencies recently. The first has been the impact of tapering and potential tightening from the US. The first whiff of this back in 2013 caused a sell-off in major risk assets and emerging market currencies, but the impact has faded, in part thanks to Fed forward guidance and secondly, owing to the general lack of inflationary pressures and declining inflation expectations in the developed world. The second theme has been the aforementioned weakening of Brazil and deterioration in its external balance position. The final one, as for many, has been the falling oil prices, which has weighed on Mexico more than most.
So what can we expect in the year ahead? Firstly, more divergence between different currency pairs. What we’ve seen as QE has had less impact and more recently been faded, is that high correlation between risk assets has declined. What was remarkable from 2012 to the first half of 2013 was just how close the Mexican and Chilean currencies traded to each other, the simple correlation peaking at 0.90 mid-2013, down to 0.20 mid-2014. When liquidity is scarcer, as is likely to be the case in 2015, then investors tend to become more discerning on emerging market risks.
This is likely to be to the detriment of the Brazilian real. With a new electoral mandate, the Brazilian President is not likely to face up to the longer-term challenges Brazil currently faces. With the current account deteriorating and the primary balance (deficit before interest payments) falling into negative territory, Brazil is not the place where investors will want to be caught in the coming year and it’s this combination of factors that will tend to make it tough going in 2015.
For Mexico, the current pressures on the currency are likely to be more transitory, unless the oil price moves even lower and the US economy takes a turn for the worse. This should mean that even if the peso does weaken further (towards the 14.50 level on USDMXN), this should prove to be only temporary. I wrote here a few months ago that the outlook for Chile was not as rosy and further rate cuts have ensued, which have weighed on the currency in the closing months of the year. This could well continue into 2015 as the economy slows further and the rate differential narrows. In sum, 2015 is going to be tough going for most of Latam, Brazil and Chile especially so.