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Policy change comes into view as LatAm market pummeling continues

Feb 4, 2014

Latin America’s falling currencies may be reaching a “critical juncture” where they could start to catalyze outflows of foreign cash or prompt central bank action, say analysts

The sustained weakness in Latin American equity, bond and currency markets could drive rate hikes, or further push international investors out of the region, analysts said on Tuesday.

While the slump in Latin currencies is not "symptomatic of an internal crisis" in the region, central banks may be approaching the limits of their tendency to tolerate export-supporting weaker exchange rates, Siobhan Morden, head of Latin America fixed income strategy at Jefferies, said on Tuesday.

The Colombian peso has fallen 5.2% against the dollar since the start of the year, while the Brazilian real depreciated 1.3% and the Mexican peso 2.3%.

"The latest FX weakness may now have reached a critical juncture whereby it could [catalyze] outflows of foreign holdings or alternatively, contaminate the inflation/growth trade-off for central banks," Morden said in a research note.

Brazil and Peru’s central banks have "significant firepower" to address currency weakness, while Chile and Colombia may intervene if contagion threatens the real economy, she said.

"Mexico perhaps faces the most challenging policy dilemma with less firepower to fund the outflows and not much flexibility to tolerate FX weakness," Morden added.

But Mexico is likely to be the least affected country if the problems plaguing emerging markets continue, said Bank of America Merrill Lynch analysts.

They expect Peru’s central bank to raise rates in the fourth quarter, or even earlier if the sol is hit. Brazil’s central bank is likely to use rate hikes and its swaps program as its "first line of defense", and so may increase borrowing costs by 50bp — rather than the 25bp expected by the market — at its next meeting, the analysts said.

"A continued rout on EM would drive the currency weaker than what it is now, in our view, but we anticipate the Brazilian Central Bank would tread much more carefully than Chile or Mexico," BofA-Merrill analysts said on Tuesday.

The weaker currencies come as equity markets also suffer. Brazil’s Ibovespa index lost 3.13% on Monday — dragged down by a particularly dire day for shares of Petrobras and construction firm Gafisa — while Chile’s IPSA fell 1.34%, echoing losses in global indices. The Mexican exchange was closed on Monday, but has also suffered this year: it closed at 40,880 on Friday, down 3.8% from its early-January peak.

Still, planned equity deals including Grupo Gigante’s sale of 253m shares in Office Depot de Mexico are set to price this week, LatinFinance understands.

Latin American debt markets are expected to have a slow week after a turbulent start to the year. "I think this is going to be a pretty quiet week. Until the market volatility clears we are not going to see much going on in the way of new issuances," a portfolio manager told LatinFinance on Monday. LF



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