Revisiting our currency forecasts - Capital Economics
Latin America Economics

Revisiting our currency forecasts

Latin America Economics Update
Written by Quinn Markwith

Latin American currencies are likely to weaken further in the coming months alongside most EM currencies. But while we expect the Chilean peso and Peruvian sol to end next year stronger than their current level, the Brazilian real and Colombian peso will probably be weaker by end-2020.

  • Latin American currencies are likely to weaken further in the coming months alongside most EM currencies. But while we expect the Chilean peso and Peruvian sol to end next year stronger than their current level, the Brazilian real and Colombian peso will probably be weaker by end-2020.
  • Latin American currencies fell alongside those of other EMs in recent weeks, following an escalation in the US-China trade war. Since early July, the Peruvian sol and Mexican peso depreciated by around 2% against the US dollar, the Colombian and Chilean peso by 4.8% and 5.3%, and the Brazilian real by 7.3%. We had expected that currencies would weaken this year. (See our Q4 2018 Outlook). That said, falls in the Chilean peso and Brazilian real have outpaced our expectations, prompting us to revisit our views.
  • Trade tensions are likely to persist, and we expect that global growth will slow further this year, causing more weakening of EM currencies. But we expect that sentiment towards EM assets will recover next year as global growth starts to turn. This will help EM currencies, including those in Latin America, to appreciate over the course of 2020.
  • Table 1 shows five key factors which are likely to drive Latin American currencies over the next year. And our old and new forecasts are shown in Table 2. Greener shades indicate that the factor should help the currency appreciate, red indicates the opposite and grey means a neutral impact. Key commodity refers to our expectations for the prices of a country’s commodity exports. External shock refers to vulnerability to global growth and US-China trade disputes, domestic risk to political/policy issues, monetary policy to the degree to which interest rates will be hiked or cut by more or less than the markets expect, and countries with large current account deficits are more vulnerable to sell-offs by foreign investors.
  • We’re most optimistic on the Peruvian sol and Chilean peso. We expect copper prices to recover over the coming quarters in part due to a shortage of global supply and forecast that it will end 2020 at 6,600$/mt, from 5,700$/mt currently. The fundamentals of both countries are strong, with low levels of sovereign debt and small fiscal deficits. These factors should help both currencies strengthen by around 5% by end-2020.
  • The Mexican peso should recover any near-term losses by next year. While a major external shock from a trade dispute with the US is not in our central scenario, uncertainty surrounding the passage of the USMCA and interventionist policymaking could result in bouts of volatility for the peso. But a small current account deficit should limit any fall, and our forecast for looser monetary policy is now largely priced into markets.
  • We’re more downbeat on the Colombian and Brazilian currencies, and both are likely to end next year lower than their current levels. In Brazil, the good news on pension reform now appears to be largely priced into markets and we expect a further 20% fall in iron ore prices next year. This, together with the looser than anticipated monetary policy that we forecast, should keep the real weak in 2020.
  • In Colombia, the current account remains large at 4.3% of GDP (on a four-quarter sum basis), and with our forecast for the price of oil to remain low, it should remain wide. We expect a sharp fall in the Colombian peso this year, before recovering some lost ground next year. But we still expect it to end next year weaker than it is now. (For more on our forecast on Colombian peso see our Update, 23rd May).

Table 1: Currency Forecast Factors

Table 2: New Currency Forecasts
(Old Forecasts in Parentheses)

Source: Capital Economics

Source: Capital Economics