Latam Charts: Taper Tantrum Redux

• March’s EM sell-off has echoes of 2013’s “taper tantrum” that imply a need for a shift in messaging at next week’s FOMC meeting.

• The Pacific Alliance countries’ (PACs’) risk assets are performing relatively well through this storm.

ECHOES OF 2013 AND AN INFLECTION POINT FOR THE FED

The recent back-up in US yields on strengthening recovery data, improving vaccination news, the Biden Administration’s stimulus package, inflation concerns, and the Fed’s pass on quelling taper speculation in its recent communications have translated into a substantial, but differentiated, sell-off across emerging-market (EM) risk assets so far during March. IIF data (subscription) show that capital flows out of EMs are reversing the recovery from last year’s pandemic-induced sell-off and are approaching the pace observed at the peak of the 2013 “taper tantrum”. Investors are looking through the potential positive spillovers from the US stimulus package on EMs, particularly Mexico, through increased demand for their exports, higher commodity prices, and direct transfers via remittances that have been estimated by, amongst others, the OECD.

All of this makes the March 16–17 FOMC meeting and ensuing Fedspeak critically important for the next few weeks in EMs. At the outset of 2013’s EM sell-off, the Fed accepted rising yields as a by-product of strengthening growth prospects, which deepened the rout when the FOMC moved ahead with the announcement at its June 2013 meeting of a plan to taper QE. Capital outflows from EMs were staunched only when the September 2013 FOMC meeting took a pass on pursuing the taper that had been teed up. Next week’s Fed communications will need to take the emphasis off the near-term quickening of the recovery and refocus markets on longer-term growth prospects in an attempt to anchor the far end of the US curve and reduce pressure on EMs. The bonus for the US is that such a move may also dampen the return to a strong USD that could impair efforts to raise inflation and boost exports.

PACIFIC ALLIANCE COUNTRIES: SAILING ROUGH FED WINDS

The Pacific Alliance countries (PACs) haven’t been immune to global market developments, but so far they are weathering the storm better than most EMs. We look at the performance of the PACs’ major risk assets since the beginning of March versus their peers.

• FX. The PACs’ currencies have performed reasonably well during the taper tantrum redux (chart 1 on p. 1, table 1, and charts 3 and 5 on p. 6).

- COP has been the star of the group, up 1.1% against the USD in March.

- The declines in the CLP (-0.62%) and PEN (-1.22%) versus the USD have been relatively contained considering the concurrent moves in copper prices.

- MXN has rebounded this week: after being down -2.65% versus the USD during the month to March 9, it has recovered to being off only -0.70% in the month. Still, the peso is down -3.4% over the last four weeks (table 1). The peso’s initial softness reflected the MXN’s role as a liquid proxy for the generalized weakening in EM risk sentiment as UST yields rose; it also priced Mexico’s relatively soft growth prospects compared with its regional peers (see our macro forecasts on p. 3). Since then, inflation and activity data, as well as the temporary suspension of the AMLO Administration’s new Electricity Industry Law, have all helped improve views on Mexico’s relative outlook.

- The BRL also benefited from a turn in sentiment this week as markets further priced a rate hike on March 17 by the BCB. After recording one of the weakest performances amongst EM FX in 2020 (chart 5, p. 6), the BRL is now up 1.38% in March.

• Bond yields. Yields have backed up and spreads have widened versus USTs, but at the 10-year tenor, for instance, Chile’s and Peru’s sovereign spreads have remained broadly in line with those of US BBB corporates (chart 6, p. 6). Colombian and Mexican government bonds have seen proportionately larger sell-offs, but the PACs’ sovereign debt continues to trade much tighter than Brazil’s paper, where a relative short average maturity heightens roll-over concerns.

• Policy rates. Benchmark central bank rates are not expected to begin normalizing in the PACs until, at the earliest, H2-2021 (forecast table, p. 3).

  - Brazil’s BCB is about to kick-off rate increases in Latam with a first move in its hiking cycle at the Copom’s meeting on March 17.

  - Colombia’s BanRep is projected to follow with an initial rate increase in Q3-2021.

  - Mexico’s Banxico is forecast to cut one more time during Q3-2021, followed by rate increases from Q1-2022.

  - Chile’s BCCh and Peru’s BCRP are set to stay on hold at exceptionally low levels until mid-2022.

• Equities. Equity markets in the PACs have broadly benefitted during March from weakening currencies that have boosted the competitiveness of domestic industries and provided a fresh buying opportunity for foreign capital (table 2).

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