Even though Pfizer and Moderna’s vaccines have been approved in several countries, at the start of 2021 the world economy still shows high levels of uncertainty as a consequence of the second wave of Covid-19. And as the foreign exchange market quickly grasps these effects, those of Latin America were seriously affected in 2020. How do the various currencies vary? What do these movements depend on? What will happen this year? All about the foreign exchange market in Latam. We go through it in this article.
In order to assess the joint behavior of Latin American currencies, we have developed an index, the Latam Currencies Index (LCI). To calculate the LCI, we considered several regional currencies, such as the Brazilian real, the Colombian, Mexican and Chilean peso, and the Peruvian sol, all on an equal weighing. The objective is summarizing how the most representative currencies of the region have behaved during 2020, and understanding how they related as a group against the US dollar.
Chart 1. Own elaboration. Data: Bloomberg
Chart 1 displays LCI compared to another very well known index, the DXY, that includes a basket of currencies from developed countries against the US dollar. The DXY has experienced a sharp downward trend since March 2020. This means that, relative to these countries, the US dollar value against the DXY dropped from its maximum level -above 100- to around 90 in January 2021.
However, for LATAM currencies, the behavior is not that clear. While the LCI reflects a revaluation from November to January -concurrent with the vaccines’ announcements- it also shows substantial volatility in 2020. This volatility can be seen between May and October when the LCI remained between 108 and 116. This reflects the absence of a determinative buying and selling force in the area. It is therefore clear that although there is an overall trend in the region, each country has its own dynamic.
2020 by Currency
Below, a second chart shows in detail the annual variation of the currencies included in the Latam Index basket.
Chart 2. Own elaboration. Data: Bloomberg.
Led by the Argentine peso, with 43.03%, and the Brazilian real, with 29.43%, a tendency towards devaluation can be seen.
In Argentina, this fluctuation relates to the lack of confidence of investors in government decisions and rules that apply to the foreign exchange market as a means to try to stop the devaluation of the peso. Among these measures is the limitation of the number of dollars that can be purchased monthly, and the so-called “parking”, which sets a time gap during which bonds issued in US dollars cannot be sold. It should be noted, however, that this time gap has been reduced from 3 days to 1 day at present.
The devaluation of the Brazilian real is mainly connected to the number of Covid-19 cases and how the Bolsonaro administration has managed the pandemic. Other currencies have shown this tendency, but to a lesser extent, with the Chilean peso, strengthened by 3.57%, as the only exception. But while these figures refer to the year in its entirety, it should not be forgotten that these currencies have, in some cases, reached historic highs. The Colombian peso, for example, surpassed 4000 pesos per dollar, boosted by flight to quality strategies by international investors.
An ingredient that has greatly affected the risk perception of the region is the expectation of economic contraction for 2021. According to the IMF’s World Economic Outlook released in October, countries from this basket are expected to show an average contraction of -8.5%. Peru, with an expected contraction of -13.9%, will be the most affected, with Brazil’s -5.8% on the other end.
All About Foreign Exchange Market in Latam: Expectations vs. Reality
2021 began with expectations of growth. Yet, as the year is projected to end with an average rebound of 4.4% – during the second peak of the pandemic and its new restrictive measures- these expectations have become increasingly questioned.
Moreover, besides all the elements related to economic growth that result from the measures taken to address the pandemic, there are singular components of political instability that have an ongoing effect on their currencies’ behavior. There are three in particular, which I consider quite relevant:
- US Dollar. Recent events, such as the storming of the US Capitol by Trump’s supporters, leave an impression of social and political instability within the country. As Biden’s inauguration gets closer, this may have meaningful consequences during the first 100 days of his administration.
- Chilean Peso. Social protests in Chile led to a plebiscite which ended with 78% of the votes in favor of amending the Constitution passed during Augusto Pinochet’s regime. This will continue to be a source of uncertainty, especially during the process of the constitutional reform, which will be carried out by a convention elected by popular vote.
- Peruvian Sol. A presidential drama took place in Peru the last November when President Martin Vizcarra was deposed after being charged for corruption. Interim President Manuel Merino resigned five days after taking office.
Latin America is an extremely heterogeneous region and understanding it is not an easy task. Even though we can be tempted to consider them as a whole, such as “Latam Emerging Countries”, it cannot be forgotten that each country has its own forces that must be taken into account to analyze all about foreign exchange market in Latam.
This report was made by Gandini Análisis for SupraBrokers only as content. It shall in no case be considered as an investment recommendation.