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Brazil versus Mexico: a tale of two monetary policies

While economists speculate over when the US interest rate cycle might turn, one region’s central banks have already started to shift – Latin America. Brazil, Chile and Peru have been among the first countries to lower rates, having started their tightening cycle far sooner than the rest of the world. What might it mean for the economic and market outlook for the region?

In early 2021, Latin American central banks were among the first to recognise the problem of high inflation and start to raise rates. The triggers were the same as elsewhere – bottlenecks in the global supply chain, rising food and fuel costs, along with the legacy of high government spending during the pandemic. They raised rates quickly and dramatically – to 11.25% in Chile and Mexico and an eye-watering 13.75% in Brazil.[1]

Unsurprisingly, the effect on economic activity was dramatic. Domestic growth in Brazil slowed materially, with GDP growth hovering between 1% and 2% for much of the past two years.[2] Nevertheless, these measures have been successful in taming inflation, with the Brazilian Consumer Price Index (CPI) falling from 12% in early 2022 to 3-4% today.[3] Lower inflation and greater predictability on fiscal spending have given the central bank more flexibility and it cut rates for the first time in August.[4]

Other Latin American central banks have also been cutting rates. In July, Chile cut its main interest rate by 1%[5] after a unanimous vote by its monetary policy committee. Peru has followed a couple of months behind, cutting its benchmark rate by 0.25% in September.[6]

Stock market response

Monetary policy easing is the most important support for both the economy and the equity market. Major stock markets in the region have already rallied in the expectation that companies will benefit from lower borrowing costs and economies will start to thrive once again.

There are also technical reasons why lower interest rates should be beneficial for stock markets. When interest rates are set at 13-14%, bonds have considerable appeal and it is tough for stock markets to compete. As interest rates reverse, these flows could start to shift, with more money coming back into equity markets. 

There are a number of individual companies that may be beneficiaries from the shift in interest rates. For example, we hold XP, an investment management platform that may benefit if investors rotate from equities to fixed income.  Pagseguro is a payments acquirer that charges merchants a fee for payment processing. It has not been able to pass through the dramatic increase in the monetary policy rate, but as interest rates are cut, its margins could improve.

Mexico: the outlier

The one exception to this happy picture is Mexico. It is likely to be the last country in the region to cut rates, with Mexican policymakers worried that accumulated shocks have pushed inflation expectations higher. There are also concerns over its closer relationship to the US, where inflation is slowing, but not yet defeated.

For the time being, the central bank of Mexico – Banxico - has kept its rates at 11.25%, with inflation sitting at 5%.^[7] It is likely to maintain this holding pattern until it is clear whether the US will enter a recession. This is weighing on the Mexican currency, which has appreciated strongly for the year to date.^[8]

Nevertheless, we are not too gloomy on the Mexican economy. It remains a key beneficiary of the re-shoring of global supply chains. Its fiscal and current accounts are in order and it has some good economic tailwinds. Ultimately, we just need greater clarity on the situation in the US.

This is likely to be a better period for Latin America. It took the pain over inflation early on and is now reaping the benefits. The region has a history of inflation shocks and its central banks are adept at handling them. Falling rates over the next 12 months may give the region a tailwind over its peers.

For more information on how to access the opportunities presented in Latin America, please visit www.blackrock.com/uk/brla

Sources:

[1] Latin America easing inflation

2 Brazil GDP Growth

3 Brazil CPI Inflation

4 Brazil central bank rate cuts

5 Chile central bank slashes rates

6 Peru central bank cuts rates

7 Banxico keeps extends interest rate increase

8 Mexico squeeze super peso

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