Latin America’s Brexit Bounce Evaporating as Fed Focus Returns

  • Brazil’s real and Chile’s peso led gains after the U.K. vote
  • Now most-accurate forecasters predict declines by year-end

Latin American currencies were unlikely beneficiaries of Britain’s vote to leave the European Union. Just don’t expect it to last, say the region’s top forecasters.

Brazil’s real and Chile’s peso were the two best-performing emerging-market currencies in the week following the June 23 referendum, favored for their relative isolation from the U.K. and, in the case of the former, high interest rates. While their post-Brexit gains are already evaporating, they’re still up 18 percent and 6.3 percent this year.

To Poland’s Cinkciarz.pl, which topped Bloomberg’s latest forecaster rankings for Latin America, those gains are overdone. The currency brokerage sees losses ahead as demand for commodities wanes and the U.S. gets closer to raising interest rates.

“While the Brexit factor is positive for Latin American currencies, they’re still strongly tied to commodities,” said Marcin Lipka, an analyst at Cinkciarz.pl in Warsaw. “Yields should bounce back in the U.S. It’ll reduce some bullish sentiment.”

Lipka predicts the real will drop 6.5 percent to 3.6 per dollar by year-end and Chile’s peso -- still the second-best emerging-market performer since Brexit -- will fall 2 percent to 680. The Peruvian sol will weaken 2 percent to 3.35 per dollar, he forecasts.

Turning Japanese

Haven status is more usually reserved for assets from Japan and Switzerland than Latin America. But the shock of Brexit is turning established norms on their head. The Brazilian and Chilean currencies, in particular, have been in demand because of the nations’ reliance on exporting raw materials -- something Britain doesn’t buy much of any more, following years of manufacturing decline. Less than 2 percent of the two nations’ exports went to the U.K. last year.

For the real, much of its appeal comes from Brazil’s high interest rate. The 14.25 percent main rate -- 38 times U.S. borrowing costs -- gave the currency the best return this year for so-called carry trades, where investors borrow where interest rates are low to buy higher-yielding assets. Deals funded in dollars to purchase the real have earned 25 percent in 2016, the most of any currency worldwide.

Most of the Latin American currencies’ gains came shortly after the Brexit vote. The real surged 3.9 percent from June 23-30 -- the most not only in emerging markets, but among 31 major peers tracked by Bloomberg. It has since given up those gains after Brazil’s central bank intervened.

Top Performer

While Latin American currencies benefited from the Brexit vote, those of Eastern Europe, more closely tied to the U.K. through trade, have been among the biggest losers. Poland’s zloty leads the declines with a drop of more than 4 percent since June 23 -- most of that coming in the first week.

Latin American currencies, including the real, sol and Chilean peso, are gaining this year because of a declining dollar, even though their economies remain weak, said Eric Viloria, a strategist at Wells Fargo & Co., the No. 2 forecaster for the region last quarter.

He predicts the real will fall 1.6 percent this year to 3.42 per dollar, while Chile’s currency will drop to 680.

Weakness Forecast

For the gains to continue, “we need to see a sustained improvement in fundamentals, a significant improvement in the fiscal side as well, and that’s something that will take time,” New York-based Viloria said. “We expect the unsettled global financial market backdrop to contribute to near-term emerging-currency weakness.”

Gustavo Rangel, chief economist for Latin America at ING Groep NV in New York -- placed third in Bloomberg’s regional forecaster rankings -- is more optimistic. He sees the Chilean peso only slightly weaker by year-end and the real gaining 4 percent to 3.2 per dollar. The Peruvian sol will remain little changed at 3.27 per dollar, he predicts.

“Brazil has the highest interest rate among emerging markets and these are likely to remain high,” Rangel said. “As long as the Fed doesn’t signal a rate hike, maintaining the broad liquidity in the markets, there will be room for the real to keep strengthening. It’s all about yield hunting.”

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