LatAm assets: shine risks coming off the real deal

Latin America’s commodity exporters have shone this year while almost everywhere else has been in darkness. Emerging market stocks in the benchmark MSCI index are down 30 per cent in the year to date; Latin American stocks have climbed 2.5 per cent. Petrobras, the Brazilian oil company, has notched up a more than 13 per cent return on the local exchange; Brazilian industrials are up nearly 18 per cent.

Across emerging markets, Russia’s attack on Ukraine has devastated many companies, especially those closest to the war. MSCI’s EM eastern Europe index collapsed after the invasion and has stayed down, off more than 85 per cent so far this year. Those further away have suffered less.

But it is soaring commodity prices, for food, fuel and raw materials, that have lifted Latin America’s markets and currencies. In a world dominated by the rising dollar, the Brazilian real has posted rare gains against the greenback this year, up more than 7 per cent.

Despite some recent weakness, the real should hold up. Thanks to a healthy current account surplus and an unusual decelerating inflation rate this year, Brazil’s currency should trade closer to R$4.50 to the dollar rather than today’s R$5.30 thinks Robin Brooks, chief economist at the Institute of International Finance.

The region’s commodity-exporting currencies should be performing far better against the dollar. In fact, the real’s gains this year — and the Mexican peso’s more modest 2 per cent rise — can be explained as much by interest rate movements as exports. Brazil’s central bank began raising rates a year ahead of the US.

As is so often the case in Latin America, political risk has intervened. Export growth is impressive. But Brazil’s knife-edge election drama, constitutional ructions in Chile and unrest elsewhere have diminished the appetite for risk among global investors. For LatAm currencies, there are more factors at play than commodity prices.