LatAm currencies to shake off the recent U.S. dollar dominance

The major LatAm currencies traded strongly in September, ending the month with quarterly losses against the US dollar. In year-to-day terms, however, the Mexican peso (MXN) and the Brazilian real (BRL) still cling to solid gains.The most recent spell of the USD strength and sharp rise in the US Treasury yields have put the emerging markets under severe pressure, and Latin American currencies are no different. A striking contrast has emerged between a hawkish "higher for longer" stance from the Fed and huge easing cycles underway in Chile and Brazil.

Although the USDBRL has recently risen above the 5.0 level and the USDCLP has breached the 900 mark, we remain positive on the real and the Chilean peso. Global growth is unlikely to deteriorate further as economic data in China and Europe may have started to improve. The US dollar rally looks overdone. We doubt that the FOMC will be able to hike rates in November. The most recent PCE data seem to support that view.

Therefore, in Q4, risky currencies might regain traction. Despite expectations for further policy rate cuts, BRL and the Chilean peso (CLP) should be supported by attractive real interest rates, which should lure as the bond market rout fades and markets settle. Campos Neto’s remarks that fiscal policy will not postpone the disinflation have no impact on the monetary policy outlook. The belief that the rates will be cut at a pace of 50 bp per meeting is deeply rooted. Conotoxia’s forecasts say that the USD/BRL pair will decline to 4.90 and the USD/CLP will drift lower to 870.

In the case of the MXN, the outlook is less clear. Banxico is set to unwind its FX forwards in order to replenish the dollars it has sold in recent years to support the struggling peso, which is perceived as a tremendous hurdle for the MXN. Next year's elections and the US economy's stagnation are also significant risk factors. In the short term, however, the economy is faring above expectations and monetary policy outlook and argues for stronger peso. Banxico confirmed its hawkish bias this week by unanimously keeping rates at 11.25 pct. The first cut is not expected before the first quarter of 2024, as inflation forecasts have been revised upwards. As a result, the peso should once again benefit from extremely high real rates, and we expect the USDMXN exchange rate to fall below 17.00 in the coming months.

Despite the pressure from the finance minister and president Gustavo Petro, who urged the Colombian central bank to loosen monetary policy, the rate was kept at 13,25 pct. The first cut might come before the year-end, and although we assume COP will follow its peers higher, it might underperform BRL and CLP due to less attractive real rates.