Latin American Commodity Currencies Have Likely Peaked; Mexico To Outperform

Over the course of the past two years, BMI's narrative of Latin American economies has shifted towards one of greater caution with regard to traditional emerging market (EM) bellwethers such as Brazil.

At the same time, we began expressing increasing confidence in the strong growth prospects for Mexico's economy over a multi-year timeframe. Meanwhile, our long-held view of a slowdown in China's economy is increasingly coming to fruition as a result of an ongoing rebalancing process away from fixed investment-driven growth towards greater domestic consumption.

Indeed, falling external demand for industrial metals has markedly debased the commodity-exporting economic growth model in Latin America, which has driven steady exchange rate appreciation over the last 10 years. By contrast, Mexico's slower pace of economic growth and its reliance on US demand for its manufactured goods exports have seen the peso's exchange rate largely lag the rest of its regional peers.

In light of the changing global economic landscape, we believe that foreign investors will increasingly discriminate on the basis of sounder macroeconomic fundamentals (e.g. domestic demand and competitive manufacturing sectors versus a high dependence on iron ore and copper exports). Although policymakers in those economies with relatively undervalued exchange rates will seek to preserve their external competitiveness, we believe that in cases where exchange rates are significantly overvalued by historical standards, this could result in a forced economic rebalancing towards greater domestic demand, or force policymakers' hands and lead to marked currency depreciation over the coming years.

Our main conclusions can be summarised as follows:

  • Most regional currencies have in all likelihood peaked earlier this year and will likely succumb to further downward pressure over the coming years, with the notable exception of the Mexican peso.
  • Economies with historically overvalued exchange rates will need to undergo an economic rebalancing, or in the absence of stronger domestic demand, weaken their exchange rates in the meantime to restore economic competitiveness. Brazil is a case in point.
  • In the absence of supply-driven inflation shocks, Colombia's central bank will continue to target a weaker exchange rate for the foreseeable future.
  • Mexico's external competitiveness means that the external sector can continue to perform well even in the event of more rapid real wage growth and rising GDP per capita over the coming years.
  • We see further scope for relative exchange rate outperformance of Mexico over Brazil over the coming years.

Our full article on the prospects for Latin American currencies is available to subscribers at Business Monitor Online.

This Week's Trivia Question

Last week's question mixed a bit of history and popular entertainment, and was as follows: which individual connects a cinematic portrayal of US General Douglas MacArthur and the American occupation of Japan with a mysterious island in the South Pacific? The answer is the actor Matthew Fox, who plays an American military officer working for MacArthur (Tommy Lee Jones) in the new film The Emperor, which opens in UK cinemas today. Fox also played Jack Shephard, a survivor of a plane crash in the South Pacific, in the US TV drama Lost, which ran from 2004 to 2010.

This week's question is as follows: Earlier this week, Bloomberg reported that a major international mining company is considering replacing its train drivers with robot locomotives to cut costs, because the drivers are reportedly paid the equivalent of US$224,000 per year. In which country and in which region of this country do these drivers operate?