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15.02.2017 | 16:49

UBS: Where is Latin America in the Cycle? Implications for Rates and FX

Despite experiencing external sector shocks of similar magnitude and timing, Latin American economies have diverged in the pace and depth of their macroeconomic adjustment.

We characterize the dynamics of macro variables for the main Latam markets and draw conclusions from the regional experience as to how interest rates and currencies for specific countries may behave.

Initial conditions and local factors influenced adjustment

Idiosyncratic characteristics, policy decisions, and political developments explained part of the divergence and will continue being important for asset prices, but taking stock of the fundamentals is critical to understanding the general trend. Current account balance started from a surplus in Chile, a small deficit in Mexico, and larger deficits in Brazil and Colombia. While Chile started the policy adjustment earlier, Brazil kept running the economy "hot" while Mexico and Colombia delayed the response in monetary policy due to late inflationary pressure. The adjustment was smooth for Chile, intense in Brazil, and still underway for Mexico and Colombia.

Rates and FX will likely follow fundamentals

External, labour, inflation and output gaps remain at different stages after six years of adjustment and the adjustment process will most likely drive the trend of policy rates for the year ahead. Local rates are cheap and yield curves are trading flat but we expect them to normalize at different speeds. We see large policy rate cuts in Brazil, milder ones in Chile and Colombia, and continued hikes in Mexico but less than what the market is expecting. We still favour Brazilian local bonds in the region.

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