August 2016 >>> Pacific Alliance Fundamental Commentary. #Forex

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MEXICO — Global risk appetite continues to be alive, providing global investors the right incentive to maintain, if not increase, their allocation to high yielding emerging-market assets, particularly government fixed-income securities. As a result, the Mexican peso (MXN) has benefited from this temporary adjustment phase affecting the USD, and maintained a relatively stable trading range between 18.25 and 19 per USD. The economic outlook remains tied to the US business cycle as well as prospects for structural fiscal adjustment under way. The government and the central bank have jointly earmarked fiscal reform as a key requirement for sustained growth through the remainder of the decade. In this regard, the Finance ministry has already executed budget cuts accordingly for 2016 and 2017. Despite weakened manufacturing activity, the economy continues to enjoy the benefits of consumer-driven growth supported by steady access to credit, robust remittances activity and relatively stable exchange rate market conditions following the 2015 weakness. In brief, deficit reduction is a key goal for 2017. The government authorities augur an improving outlook for reform of the state-owned oil firm PEMEX, and its contribution to the country’s economic situation in the year ahead. On the monetary front, the recent central bank adjustment in its reference interest rate has been widely seen as a pre-emptive move against potential inflationary inertia from the recent exchange rate adjustment and potential adjustments to administered energy prices in the months to come.
Despite the surprise 50bps hike by Banxico, MXN was a bottom 20% major FX (-2.3%) in July, with its proxy hedge status weighing despite a higher carry (currently close to 4.5%, vs 2.8% last November). Going forward, its worth watching the US election’s trade related discussion, as both major parties have mentioned re-negotiating NAFTA, and one of the candidates has suggested ending it. Close to 80% of Mexico’s exports go to the US, meaning this risk is relevant.
COLOMBIA — The Colombian currency environment remains primarily influenced by external factors connected with crude oil price dynamics and risk appetite for emerging-market assets. The steady retrenchment in oil prices (down 23% since its six-month peak at US$51.7 per barrel on June 9th) has been the dominant factor weighing on the value of Colombian peso (COP) of late. Global risk metrics still point towards persistent demand for emerging-market debt assets, including Colombia. However, international investors seem to be differentiating amongst Latin American sovereign credits, and Colombia has been punished by the persistently wide twin (fiscal and current account) deficit position. In addition, the Colombian sovereign rating outlook remains on “negative” watch, as international credit agencies remain attentive to the long-awaited structural fiscal reform package to be debated by Congress in the coming months. On the monetary front, the country’s monetary authorities continue to fiercely fight domestic price pressures (and inflation expectations) through an aggressive tightening stance; indeed, the Colombian central bank opted, once again, to increase its policy-setting reference rate by 25 basis points to 7.75% at the end of July. Banco de Colombia acted in response to high single digit inflation at the end of June as a result of persistent food-related inflation pressures, ongoing structural indexation mechanisms and inertia from exchange rate adjustments. Persistent inflation and widening twin deficits will continue to weigh on the COP outlook in the months ahead.
The drop in oil prices we saw during July (WTI is down to near US$42/bl) gave COP a blow to the chin, that made it the worst performing major FX (-4.1%) after the Turkish Lira (-4.7%, on the back of the political noise related to the failed coup attempt). Colombia’s wide current account gap remains a source of potential headwinds for the peso, given it is still not clear if the modest improvement was simply driven by the oil price rebound, which is fading.
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CHILE — The combined effect of a stable USD and recovering copper prices translated into a relatively stronger Chilean peso (CLP) over the past two months, reinforcing positive trends since the beginning of the year. The CLP, as most currencies in Latin America, were mostly indifferent to the global shock waves caused by the UK referendum vote last June. The recovery of the euro (EUR) vis-à-vis the USD was also another externality supporting trading dynamics in commodity-sensitive currencies like the CLP. For now, global market participants are not very preoccupied by the weak economic recovery in Chile. Nevertheless, recent macroeconomic data highlighted the erosion in labour market conditions as the unemployment rate jumped to 6.9% as of June 2016. The Chilean economic recovery remains on a slow track in line with less benign global trade conditions. Real GDP is estimated to expand at around 1.7% this year before accelerating to a 2% expansion rate in 2017 on the back of a jump in delayed investment decisions and improved global economic conditions in the country’s major trading partners. Chile retains the highest rating within Latin America irrespective a relatively soft economic growth environment. On the monetary front, the central bank will most likely adopt a neutral stance in the months to come as there no evident signs of stress affecting the inflation scenario in the months to come; consumer prices increased by 4.2% y/y last June.
The Chilean peso had a fairly neutral month, basically trading flat to its level at the end of June. This performance is consistent with the mid-pack performance of the Chilean economy, where growth is expected to remain positive, but unspectacular, inflation has stabilized near the top of the BCC’s target, while the balance of payments seems to be adjusting to less favourable terms of trade. Overall, CLP is somewhat of a reflection of a steady but unspectacular economy.
PERU — A new government is in place. Pedro-Pablo Kuczynski assumed the presidency of Peru on July 28th. The new administration inherits an economy in motion despite a relatively fragile global economic recovery. The Peruvian economy offers a promising outlook on the back of a major boost to be injected by the government’s infrastructure development program and the inertial effect from an increased in mining production. Domestic demand is also expected to contribute to an accelerating growth path on the back of steady access to local credit and contained inflation. Indeed, headline inflation moderated once again reaching a 12-month rate of 2.9% y/y last June. The prestigious Central Bank has left its policy-setting reference rate unchanged at 4.25% since early February; and no policy rate adjustment is in sight. Exchange rate market conditions have been reflecting a relatively benign external context coupled with positive expectations following the outcome of the recent electoral cycle. The Peruvian Sol (PEN) is trading at the six-month average rate of 3.4 per USD, hinting at a high degree of resilience to external market shocks (i.e., UK referendum on June 23rd) and/or heightened policy/electoral risk in advanced economies (i.e., US presidential vote on November 8th). In brief, Peru offers a stable and growing economic context over the next 18 months. Major structural reforms, particularly to reduce the high level of informality, are widely expected by long-term investors.
Following Governor Velarde’s announcement that the BCRP could become more active buying CDs, the sol has lost some of its shine, leading it to shed about 2% of its value vs the FX, despite news on both the growth and political fronts being quite constructive. With incoming President Kuczynski signaling potential new mining projects for the country, the central bank may be forced to start leaning vs sol appreciation more forcibly, unless the USD’s trend turns once again.
Regards All.
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