Walter Molano | Who holds the trump card?
With President Donald Trump sitting in the White House, many people are asking what lies in store for Latin America.
The attitude of the United States towards the region for the past three decades has been mainly one of benign neglect.
This hands-off approach allowed it to develop politically and economically. It enjoys the trappings of democracy, with a few exceptions. The economies are relatively sound, but they are highly vulnerable to external changes.
It is hard to imagine that the benign neglect attitude of the US government will end with President Trump, even though he has a number of important property investments throughout the region.
Nevertheless, it will be affected as the Federal Reserve embarks on a new phase of monetary tightening.
A massive fiscal stimulus, an overheating economy and demographic change will put upward pressure on US inflationary forces. As a result, yields will rise and several asset markets, such as equities, commodities and real estate, will rally.
A similar trend, albeit with less vigour, will occur in Europe, reducing the demand for the emerging market instruments.
We must recall that the emerging markets are an alternative asset class. They are a substitute for when the core markets face challenges, as they did after the financial crisis, when interest rates were extremely low and GDP growth rates were abysmal.
With the US economy poised to grow more than four per cent in 2017 and rates moving higher, investors are moving back to more familiar terrain. This will create severe challenges for Latin America, but particularly for the countries and companies that are more dependent on the international capital markets.
Top of the list are serial issuers, such as Argentina, Pemex and Petrobras. All three scurried to the market as soon as they could before investor sentiment changed.
Like a recovering alcoholic who just downed his first shot of whiskey in 12 years, Argentina has plunged off the wagon. It has issued more than US$10 billion since the start of the year, and it still has US$30 billion to go before year end.
High-grade issuers, particularly the Andeans, will see rising yields, due to the increase in Treasury rates, but could see their spreads contract due to better export earnings. The devaluations of their currencies boosted their competitiveness.
The stronger dollar is a boom to Latin American exporters, many of whom have suffered from overvalued exchange rates for almost a decade. Commodity prices will also move higher as global aggregate demand expands.
With the US and China growing at almost the same pace, there will be greater demand for raw materials. Declining commodity output due to years of weak capex will surely keep raw material prices high, thus improving the creditworthiness of many Latin American countries.
Venezuela will be the outlier. It will continue to suffer from internal political and social unrest. Fortunately, improving oil prices will ease some of the pressure on PDVSA and the government.
We believe oil prices will end the year above US$60 per barrel, thus providing Venezuela with a significant boost. We do not believe that it will default in 2017, but the political drama will continue.
Brazil will be in a similar situation, due to its ongoing political problems. Still, the improving trend in inflation, the external accounts and fiscal policy could make Brazil one of the better performers in 2017.
However, the unexpected star in 2017 could be Mexico. Despite the rhetoric from the White House, the Mexican economy will benefit from the economic revival of the US.
The correlation of GDP growth between the two countries since 2007 has been about 80 per cent. Back in 1991, when NAFTA was signed, the correlation was 18 per cent. However, it took decades for US manufacturers to move some of their capacity south.
Today, Mexico is an integral part of the US industrial base. The expansion in US economic activity will surely be felt south of the border.
Most of the companies that announced changes to their Mexican investment plans were part of the small universe of firms that received government backing in the past, such as Chrysler and General Motors, or depend heavily on government contracts, such as Carrier/United Technologies. It is only natural that they kowtow to the new powers in Washington.
Still, the larger set of corporations that are not as dependent on government assistance or projects will continue to operate unabatedly, and provide a strong boost to the Mexican economy.
In other words, there will be winners and losers in 2017, but Mexico could be holding the proverbial trump card.
- Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.