FX Sell-Off: Higher Stakes For Policymakers In Rebalancing Act

The key drivers of relative exchange rate performance in Latin America will be the quality and reliability of economic growth over the coming quarters. Regular readers will be well aware that we have long been highlighting major shortfalls in Brazil's economic growth model in light of a challenging operating environment and decelerating growth in China. In contrast, we are less concerned about Mexico's economic growth model, having long suggested that the ongoing reform drive by the government and trade integration with the US will see the economy outperform many of its Latin American peers in the near future. As such, we believe that the secular outperformance of the Mexican peso over the Brazilian real will continue over the coming quarters irrespective of the negative implications for the carry trade as Brazil's central bank continues to hike interest rates.

Despite more favourable macroeconomic fundamentals, currencies such as the Mexican peso, have also been hit hard by the latest flight to safety among investors. A more robust growth outlook and favourable business environment have not prevented a spike in volatility given Mexico's deep capital markets and large share of short-term capital in the financial account. From a technical perspective, we take a more cautious outlook on Latin American currencies in the near term in light of notable chart damage.

That said, the peso appears to have come right off the MXN13.60/US$ level in recent trading and could be basing around MXN13.40-13.50/US$ before setting up for another run at resistance near MXN13.20/US$ over the coming weeks. Although major gains against the US dollar are hard to see beyond these levels, we believe that relative outperformance over a basket of EM currencies, particularly those with higher current account deficits and questionable growth dynamics, will continue.

Fundamentals Trump The Carry Trade
Exchange Rate, MXN/BRL, Weekly Chart

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This article is tagged to:
Sector: Country Risk
Geography: Latin America, Argentina, Brazil, Chile, Colombia, Mexico, Peru

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