It might not be a mutual love affair, but there’s lots of reasons for many Latin Americans to swoon at the appointment of Janet Yellen as Fed Chairwoman. This post is the first in a three-part series aiming to give some context to what this big announcement means for the region and what we can expect in the coming months and years as a result of Yellen’s appointment.
Before I delve into country specifics in post two and winners and losers next year in post three, let’s start from the beginning.
Tightening US monetary policy has real consequences for LatAm, particularly in the context of import markets, competitive export advantages, local rate environments, and, not unimportantly, their ability to repay dollar denominated debts. And those are all just mere appetizers to the rump roast that is inflation.
This is why Latin America has watching this appointment closely, mainly because there is a real sense that continued loose money policy will enable LatAm to stay in a relatively low rate environment all while propping up the value of their currencies compared to the USD, keeping imports cheap, foreign reserves amassable, and commodity prices high.
However, if tapering begins and goes at a quicker pace than markets have been expecting, we could see an important problem for much of Latin America at a fragile time for many of their economies.
The prospect of a dove at the helm of the Federal Reserve gives Latin America hope that the unknown consequences of an aggressive reformer are unlikely to see the light of day. As Yellen has signaled in her long and distinguished tenure in the bank, her appointment should coincide with a push to retain the fed’s dual mandate of full employment and low inflation through more dovish measures, keeping tapering from tightening reigns too much.
What goes down must come up
Still, even the doves know that QE can’t last forever, and the Fed will need to eventually relinquish the asset buying programs it pioneered after the financial crisis. For Latin America, this means that rates will have to rise as well, and likely at a greater pace to attract capital away from the us as also to slow the pace if record consumer growth and borrowing over the past several years.
The Times, while assessing the decision’s impact on emerging markets worldwide, concluded:
“The emerging economies facing the biggest challenges in recent months have been wrestling with broadly measured trade deficits equal to several percent or more of their annual output. They have relied until now on foreign investment to pay for these deficits as well as to finance interest payments on foreign borrowing, making them especially vulnerable to capital outflows that have reached tens of billions of dollars over the summer.”
While this is broadly true, the characterization is generally unfair in a Latin American context. This is because, for the first time in many decades, sovereign debt is manageable, growth is sustained rather than happening in fits and starts, For me, what is really remarkable about the last few years is the coincidence of Latin American governments having their economic houses in relative order and the chaotic, then sclerotic developed world macro environment.
Loose policy in the US and elsewhere over the past few years has given Brazil, Mexico and Colombia a relatively stable environment to conduct their own responsible monetary policy. At the same time that money was cheap here in the US and in Europe, the relative high returns of Brazil and Colombia (and to some extent, Peru) in particular drove capital their way, which proved a boon to economies in a strong phase of growth. If we were having this conversation ten or twenty years ago, the truth is that sovereign, dollar-denominated debt would have been a big part of the problem. But, with the exception of some isolated cases like Peru, it isn’t.
Still, as growth has faded over the past few years the picture becomes a lot more complicated.
The biggest problem is inflation, with rates in a number of countries (most notably Brazil) hitting the top of forecasts and targets, the prospect of an external shock that drives down the value of the currency will hit consumers hard in the short term. This is particularly true for the storied new middle class that has based the majority of their “middle-classness” on the fact that they can buy imported goods relatively cheaply. Once that floor falls out, 20-cent bus fare increases will seem like a drop in the ocean.
Also complicating the picture is the growing presence of China as both a customer and a lender in Latin America. China obviously does not operate independent of global macroeconomic trends, but its own policy and capital flows in and out of the country to Latin America operate broadly outside of the free market. It is a much more complex argument than we’d like to discuss here, but a relevant factor to keep in mind.
In brief, although the status quo will likely rule the day with Yellen at the helm, important challenges await the region once the inevitable tightening begins to happen.
Stay tuned for the next post where I’ll drill down into more country-level detail on what Yellen’s appointment, and continuity in US monetary policy, means to different key economies in Latin America.