Latam Charts: The Week that Shook the World

• Fed tightening highlights a week in which advanced economy central banks accelerated the pace of tightening and/or signaled more aggressive actions to rein in inflation and prevent inflation expectations from becoming unmoored.
  

• The initial market reaction to the Fed’s 75 basis point hike was “dovish,” as the Fed burnished its price stability credentials. But a subsequent large bearish decline and increased volatility in markets suggests the Fed has its hands full convincing markets that a soft landing is still possible.

• For the Latam region, market gyrations translate into less favourable external financial conditions, which increase the premium on sound policy frameworks and strong institutions.

Well, if not the world, then financial markets. The past week saw some dramatic moves by key central banks as markets looked into the eyes of a bear. The Fed’s 75 basis point rate hike and more aggressive communications, signalling the possibility of another 75 bps move, certainly caught the market’s attention. As Scotiabank’s Derek Holt pointed out, however, the initial market reaction was surprisingly dovish. That response followed earlier sharp downward movements in financial markets, reflecting growing pessimism that a so-called soft landing, in which the Fed succeeds in returning inflation to target without triggering a recession, is becoming progressively less likely.

For the Latam markets (and emerging markets around the globe), higher advanced economy interest rates, coupled with skittish investor risk appetite, make for a less favourable financial environment, albeit one that the region has managed through with considerable poise. Past editions of the Latam Charts and Latam Weekly have noted that central banks in the region have been proactive in fighting inflation; indeed, they have led their global peers. In this respect, an interesting counterfactual to consider is what financial conditions would be had Latam central banks temporized with price pressures as others have done.

KEY ECONOMIC CHARTS

Regardless of this alternative scenario, and the growing external risks, it is apparent that the regional recovery remains on track. Scotiabank teams expect real GDP growth to moderate to pre-pandemic levels (chart 1), as output and employment levels return to where they were before the pandemic struck. The latest prints—economic activity in Colombia, GDP in Peru—are consistent with this trend. Nevertheless, the risks to this outlook have increased and high-frequency monthly activity indicators (chart 2) should be closely monitored for nascent signs of a stalling economy.

High inflation continues to persist across the region, with headline inflation running above central banks’ inflation targets (chart 3). But strong commitments to price stability, coupled with the policy actions already taken and the additional steps that have been telegraphed, lead our country teams to anticipate a gradual return of inflation to target over the coming year. With the policy rate hikes Latam central banks have put in place, policy rates are now positive in real (after inflation) terms, significantly so in Brazil and Chile (chart 4). In this regard, the proactive response by the region’s central bankers stands out in comparison to their global peers (chart 5).

At the same time, the strong economic rebound in 2021 and continued growth in 2022 have been instrumental in bringing down large pandemic-related deficits (chart 6). Fiscal outcomes in Peru have been especially impressive, though possibly inadvertent as the government investment has atrophied. Colombia’s public finances have likewise improved significantly, with it now appearing that the country is on track to return to its medium-term fiscal anchors much faster than anticipated.

Improved fiscal outlooks should help the region weather the financial storms that may be brewing in global financial markets. Lowering debt-to-GDP ratios (chart 7) and reducing external debt burdens (chart 8) would provide a confidence boost to investors anxiously watching external financial conditions. Moreover, sound public finances would also rein in large current account deficits (chart 9) in Chile and Colombia and help bolster international reserves that serve as a buffer to external shocks.

KEY MARKET CHARTS

Despite the shared financial shock of an appreciating US dollar, growing concerns of recession, and continuing geopolitical tensions, regional financial markets have performed reasonably well through the first half of 2022. Most currencies are up against the USD since the start of year (chart 3), though the strength of the dollar has clearly weighed on Latam currencies more recently. And while many regional equities markets are down on the year, these movements should be viewed in the context of volatile global markets (4). That is not to say, however, that there aren’t risks to price into financial assets. Political and policy uncertainty remains across the region, with constitutional drafting in Chile, a presidential election in Colombia, concerns with respect to policy changes that could dampen foreign investment in Mexico and continuing political machinations in Peru. Such uncertainty may be reflected in exchange rates (chart 5) and CDS spreads on Latam sovereign bonds (chart 6), which have waxed and waned in response to indications of greater or lesser uncertainty.

YIELD CURVES

Most yield curves across the region are now inverted or flat (charts 1–20). As noted in previous editions of the Latam Charts, this could be an early indicator of recession, albeit one that should not be given inordinate weight. Colombia and Peru are the exceptions here, as they have been through the yield curve inversion in other Latam countries.

KEY COVID-19 CHARTS

Jurisdictions around the world are easing masking and vaccine requirements as the COVID-19 virus fades from public consciousness, if not public health concerns. Key monitoring charts for what remains a potential threat to public health and economic health are provided below.

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