Economy

“Flight to quality” deepens run against LatAm currencies

5th March 2020

By Ignacio Portes

“Flight to quality” deepens run against LatAm currencies

Those following Latin America might have got used to headlines about devaluations in Argentina or in hyperinflation-ravaged Venezuela, but the run against the continent’s currencies is now becoming more generalized, as weaknesses are exposed amid an global investors’ “flight to quality”.

The Brazilian real lost 15 percent of its worth since the start of the year, trading at 4.67 per dollar today from 4.03 in early January, when it broke a psychological barrier of 4 reals per dollar below which it had always held since 2002.

Things are not too different for the Chilean peso, which lost 10 percent since the turn of the year and now trades at 825 per dollar, part of a much more spectacular decline since political protests intensified in the country. A year ago, the Chilean peso was trading at 585 per dollar, an incredible difference for a country with very low inflation.

</p> <p>The Uruguayan peso, which endured the contagion from <a href="https://gettheessential.com/economy/2019/03/28/the-pesos-downfall-could-just-be-getting-started">Argentina</a> since its 2018 crisis, is now suffering at the hands of its other giant neighbor and trading partner Brazil, reaching new lows this week to touch the 40 pesos-per-dollar figure. In Colombia, the movement has been slower, but its currency also lost 9 percent since the turn of the year, and tied its lowest modern value at 3545 per dollar, cents away from a new record low.</p> <h2>Global fears</h2> <p>Although each country has its quirks and specificity, the correlated nature of the trend has been impossible to ignore for analysts.</p> <p>According to Chile&#8217;s daily <a href="https://www.latercera.com/pulso-trader/noticia/inversionistas-liquidan-posiciones-en-activos-locales-y-saltan-tasas-de-bonos/DRVTP3IQTZBG5LXABK6FR52MOI/">La Tercera</a>, which quoted a local expert, the move &#8220;has to do with the flight-to-quality phenomenon, as there&#8217;s increased appetite for safe haven assets such as investment-grade fixed income instruments&#8221;, like US Treasury bonds.</p> <p>Yields on the 10-year US Treasury got below 1% for the <a href="https://www.cnbc.com/2020/03/03/treasury-yields-rise-after-stimulus-hopes-lift-risk-on-sentiment.html">first time ever on Tuesday</a>, a sign which some analysts saw as pointing towards <a href="https://www.bloomberg.com/news/videos/2020-03-04/u-s-10-year-treasury-yield-screams-recession-says-allianz-gi-s-dwane-video">potential recession</a> and, in particular, to a run against bad-quality assets, including so-called &#8220;<a href="https://www.bloomberg.com/news/articles/2020-03-03/bearish-bets-on-15-billion-junk-bond-etf-surge-before-fed-move">junk bonds</a>&#8220;.</p> <p>Junk corporate bonds and Latin American assets have one common characteristic: they were all lifted when global investors were in risk-off mode, partly aided by Central Bank&#8217;s expansive monetary policies across the globe. The US Federal Reserve has pushed on with more rate cuts this week, as worries of a coronavirus-led slowdown increased, but fears that the Fed might be running out of ammunition to keep lifting all boats has led to capital flight out of the riskier assets.</p> <p>Investors are increasingly believing that central banks across the globe will have to resort to more money printing or rate cutting to keep governments afloat, so currencies are among the first suspects to run away from, as the rise in gold to new 9-year highs last week proved. Emerging currencies, however, are likely to suffer more than those of historically financially stable nations.</p> <h2>Brazil&#8217;s laissez faire</h2> <p>Although some Latin American countries reacted to the run against their currencies in a defensive fashion, selling US dollar reserves or imposing currency controls to try to keep them afloat, Jair Bolsonaro&#8217;s policymakers have gone the opposite way.</p> <p>Central Bank chief Roberto Campos Neto has insisted on a low-interest policy over the last few months, while Economy Minister Paulo Guedes dismissed fears surrounding the devaluation saying that &#8220;even domestic workers were going to <a href="https://oglobo.globo.com/economia/guedes-diz-que-dolar-alto-bom-empregada-domestica-estava-indo-para-disney-uma-festa-danada-24245365">Disneyland</a> for their holidays&#8221;. Although Guedes later apologized for his comments after the opposition argued they were of a discriminatory nature, they highlight a <em>laissez faire</em> approach to currency movements that is uncharacteristic elsewhere.</p> <p>&#8220;Devaluation is not the main concern for Brazilians,&#8221; <a href="https://brazilian.report/">Brazilian Report</a> journalist Gustavo Ribeiro told <em>The Essential</em>. &#8220;As long as unemployment or wages don&#8217;t get much worse, Bolsonaro&#8217;s government will be fine even if the currency moves.&#8221;</p> <p>Still, Guedes is looking to insist on constant pro-market reforms to keep capital from flowing out of the country, Ribeiro said, pointing to a bill to cut benefits for state workers that is currently struggling to move forward in Congress as legislators prioritize the coming municipality elections. Last year, Guedes managed to pass a <a href="https://gettheessential.com/economy/2019/07/25/labor-reform-pension-reform-argentina-macri-election-imf">pension reform</a> that was among his most coveted market-friendly projects.</p> <h2>Conflict on the rise</h2> <p>Whether Guedes&#8217; reforms will manage to attract capital to Brazil remains an open question, but it&#8217;s clear that his approach would be harder to replicate elsewhere.</p> <p>Chile&#8217;s <a href="https://gettheessential.com/economy/2020/02/06/will-protests-mark-the-end-of-the-chilean-model-economic-hegemony">pro-market hegemony</a> has come radically under question over the last few months, as violent clashes between policemen and protesters continue and the country readies a referendum to reform the constitution, looking for a more interventionist approach.</p> <p>A similar (though so far somewhat less pointed) conflict is taking place in <a href="https://gettheessential.com/politics/2019/12/05/colombia-joins-regional-tide-with-biggest-protests-in-decades">Colombia</a>, where activists have also highlighted the &#8220;anti-neoliberal&#8221; nature of the uprisings.</p> <p>In Argentina, Macri&#8217;s <a href="https://gettheessential.com/economy/2019/09/05/macri-re-imposes-ban-on-dollar-purchases-as-crisis-reaches-banks-currency-controls-argentina-cepo-clamp">re-imposition</a> of <a href="https://gettheessential.com/economy/2019/10/31/peso-bounceback-unlikely-to-last-long-currency-controls-macri-clamp-cepo-dollar-inflation">ultra-strict</a> restrictions on capital outflows (since then tightened even further by Alberto Fernández) have meant that the official value of the peso has held relatively still, and even the black-market value has not suffered in the last couple of weeks due to a relatively strict monetary approach from Economy Minister Martín Guzmán, although the situation of the country&#8217;s Central Bank remains fragile, not to mention the ongoing renegotiation of its debt.</p> <p>In any case, the devaluation seems to be ignoring political colors. After years in which, bar a couple of exceptions, most countries in the region had relatively stable exchange rates, Latin American countries should be as ready as possible for a return of currency fragility.</p> <p>

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Ignacio Portes

Ignacio Portes is The Essential's General Editor. Former Economy editor at the Buenos Aires Herald, he has also written for publications such as Naked Capitalism, NSFWCorp and Revista Debate.