Latin American Currency Review
The early-2023 resilience in the US economy and stubbornly high inflation, which triggered a sharp repricing in expectations for how high US interest rates could reach this cycle was an initial factor underpinning the USD rebound. This has since morphed into safe-haven demand as ructions across the US regional and European banking system raised concerns about the outlook for the global economy, and generated bouts of financial market volatility.
The global economy has entered a more challenging phase. The growth and financial market spillovers stemming from the very large and very fast lift in US and global interest rates implemented over the past year to help bring down rampant inflation have started to bubble to the surface. We expect more of the economic and market effects to show up over the months ahead. In our judgement, this, in conjunction with still sticky and high US inflation, and the US Federal Reserve’s ‘restrictive’ policy stance, should help keep the USD supported over Q2 2023.
However, while we believe the USD should remain firm near-term, we don’t anticipate the USD to make new highs. Indeed, the USD ‘peak’ looks to be behind us with the Q3 2022 heights not expected to be bested. Looking back, we have found that the USD has typically moved in large multi-year cycles. With the latest multi-year upswing ending, we are of the view that the USD should weaken over the next few years once the current uncertainty about the global backdrop subsides, and as other relative fundamentals such as growth and policy expectations continue to shift against the ‘overvalued’ USD in favour of the other major currencies such as the EUR, JPY, and CNY.
The AUD has endured a volatile start to 2023. The initial China-reopening induced optimism, which propelled the AUD higher over January, quickly gave way to a stronger USD as US interest rate expectations adjusted higher following a run strong US activity data and higher than predicted inflation. The more cautious and pragmatic guidance from the RBA following its early-March interest rate hike, suggesting it may take measured steps from here, coupled with the bouts of negative risk sentiment as stresses emerged across part of the US and European banking systems also acted to weigh on the AUD.
We think the AUD’s recent swings could be a taste of things to come. Financial market volatility looks set to continue over the next few months, in our opinion, as the aftershocks from the most abrupt global monetary policy tightening cycle delivered in several decades continue to show up in markets. At the same time, the global economy should continue to slow materially under the weight of very high interest rates which are designed to constrain activity and bring down inflation down the track. We see the AUD tracking in a $0.66-0.69 range over Q2 2023 as the crosscurrents of ongoing pockets of market turbulence, global recession fears, and stronger commodity demand on the back of the re-awakening Chinese economy play out.
Beyond the next few tricky months, our underlying view is for the AUD to edge up towards the mid-$0.70s by early-2024. We think that once the worst of the global downturn passes over Q3/Q4, signs of improving economic momentum, combined with a stronger Chinese economy, and a definitive shift in stance by the US Fed from being a rate hiking ‘inflation fighter’ to rate cutting ‘growth supporter’ should act to bring down the USD and boost the AUD.
USD/CLP has edged up modestly over February and March. The initial upswing in US interest rate expectations and stronger USD generated by better than anticipated US economic and inflation data has been compounded more recently by shaky risk sentiment as banking sector concerns have grown across the US and Europe.
Our expectation is for the USD, and in turn USD/CLP, to remain under some upward pressure over Q2 2023. Further bouts of market volatility look likely, in our view, as the full effects of the biggest and fastest monetary policy tightening cycle in ~40-years continue to materialise. And although the reopening of China’s economy following its shift away from COVID zero should provide additional commodity demand, we doubt it will be enough to full counteract the interest rate induced downturn underway across the other major economies. We believe a deceleration in global activity, which is what a range of leading production and trade indicators are pointing to, should exert some more downward pressure on commodities, particularly cyclically sensitive ones like copper. Given its influence on Chile’s terms-of-trade this would be an added near-term headwind for CLP.
That said, over the next year or two, we and the market consensus project USD/CLP to move lower. Consensus is looking for USD/CLP to fall to ~792 by Q1 2024 as the forecasted USD downturn takes hold, and as the start of the next global economic upswing, continued strong growth in China, and robust structural demand for commodities like copper on the back of the decarbonization/electrification push bolster currencies like the CLP.
The relentless upward pressure USD/ARS has been under over the past few years shows no signs of letting up. Since the end of 2019, USD/ARS has risen by a staggering 241%. We, and the market consensus, expect USD/ARS to continue to move higher over the short- and medium-term, with a lift above 300 by the end of 2023 anticipated by the broader analyst community.
Argentina remains mired in an economic and currency crisis. The mix of structurally weak growth, a bloated fiscal deficit, rampant inflation, fears of another debt default, political instability, dwindling FX reserves, and the ARS’ eroding purchasing power continue to feed off each other. Indeed, there looks to be no end in sight for this circular ‘doom loop’ with even sky-high interest rates not enough to entice saving and investing in pesos. In its last attempt to help steady the ship and stem the ARS’ downward spiral, Argentina’s central bank raised rates by a lofty 300bps in mid-March, lifting the key policy rate to an eye-watering 78%. Yet this hasn’t been sufficient to alter the capital flow picture and savings/investment imbalance in support of the ARS given inflation exceeded 102%pa in February. This is a high since hyperinflation ended in the early-1990s, and as a result real interest rates remain deeply negative in Argentina. We don’t anticipate this backdrop to change any time soon.
Currency Strategist - APAC