Hoping for a Central-Bank Pivot?
Forget the Fed and Look South
Interest rates in places that started tightening policy early, like Brazil, could start coming down before they peak in the U.S.
By Jon Sindreu
Updated Nov. 21, 2022 8:43 am ET
Wall Street is currently obsessed with guessing when the Federal Reserve will stop raising interest rates. Rather than waiting for this much-discussed “pivot” in the U.S., however, investors may be better served by scouting out emerging markets first, especially Latin America.
The stock-market rally that started earlier this month with a soft U.S. inflation figure has started to fade, as recent statements by officials cast doubt on the idea that the end of aggressive monetary tightening is nigh. Last week, Federal Reserve Bank of St. Louis President James Bullard said rates would likely need to be set between 5% and 7%.
One-year Treasury yields are hovering around 4.8%, which seems too low. A recession in rich countries now seems probable, but, if this year is any guide, that won’t deter central bankers from focusing solely on inflation.
Counterintuitively, developing nations could be the ones leading the Fed.
This is because many of them started tightening monetary policy much sooner, in mid-2021. Back then, expectations that the U.S. would lead the post-Covid recovery drove up the dollar, weakening other currencies. Later, commodity shortages and Russia’s invasion of Ukraine led inflation to surge and the global investment mood to sour, triggering massive capital outflows from less-developed regions.
The economies of the more industrialized countries, often found in East and Southeast Asia, have been harder hit, which has made policy makers wary of raising rates too fast or too high. By contrast, the traditionally weaker Latin American commodity exporters have fared better, enabling them to act preventively.
Brazil, Chile and Colombia stand out, as well as Hungary, having started their tightening cycles at least 150 days before the Fed, and having gone much farther than their peers. This gives them more scope to slash rates, making their local-currency bonds particularly attractive. Mexico, Peru and Poland seem well-positioned, too.
...suggesting they may end up slashing rates as the Fed carries on, like in 2016-18Change in central-bank benchmark interest rates during the Federal Reserve's tightening cycle between?2016 and 2018Source: FactSet
There is a precedent: During the Fed’s previous rate-rising cycle between 2016 and 2018, many of these countries rushed to front-run the U.S. By the time the Fed stopped increasing borrowing costs, they had already cut them a lot. Mexico was the big straggler, but it has a new strategy this time around.
Of course, bond markets are already pricing in some of this reversal in the form of inverted yield curves, as has happened in the U.S. In Chile and Hungary, 10-year yields are far below one-year ones.
In Brazil, though, longer-term bonds seem cheap, especially considering how far the central bank has pushed up rates, and how much it cut them in 2017. Even if Luiz Inácio Lula da Silva‘s presidential reelection isn’t as good for the country’s stocks as some investors hope, its debt offers potential upside. So might Mexico’s.
Colombia is for the more adventurous: The yield curve is still pointing upward, but inflation is higher and has weighed on the Colombian peso. This explains why local-currency debt there has returned a negative 33% this past year, JPMorgan indexes show, compared with minus 15% for broader emerging markets and a positive 12% and 6% return in Brazil and Mexico, respectively.
Still, further currency woes may be capped, because rates relative to inflation remain higher in Latin America than in Eastern Europe or developed markets, where commodity dependence has been destructive. Also, the dollar rally appears to at least have slowed.
As Francesc Balcells, head of emerging-market debt at FIM Partners, puts it: “Emerging-market local bonds give investors domestic duration and currency risk, both of which are now attractive.”
Pivoting could follow a Latin rhythm |
