Latin America
The new fiscal framework will fail to prevent the rise of the public debt-to-GDP ratio as it relies on overly optimistic revenue growth. A rising public debt-to-GDP ratio will lead to a widening fiscal risk premium in Brazilian financial markets. We are making two new recommendations: downgrade Brazilian sovereign credit from neutral to underweight, and go long Brazilian CDS / short Mexican CDS.
Colombian assets are inexpensive, but they are cheap for a reason. The economy is entering a growth recession while inflation will remain sticky and above target. Further, President Gustavo Petro’s policies will lead to lower investment, rising political volatility, and public debt deterioration. Continue underweighting Colombia across all asset classes.
The Chilean economy is entering a recession. Inflation will drop rapidly and the central bank will cut rates meaningfully in H2 2023. We continue to recommend a structural overweight across Chilean risk assets on the basis of falling inflation and local yields, record cheap valuations, and dissipated political volatility.
Mexico is caught between crosscurrents. On the one hand, headline and core inflation are at multi-decade highs. On the other hand, genuine inflationary pressures are subdued, and fiscal and monetary policies are hawkish. Going forward, the economy will decelerate meaningfully, but likely achieve a soft landing as the central bank will be able to cut rates in H2 2022. Further, the nation’s healthy external accounts will put a floor in the domestic slowdown. We continue to overweight Mexico across all EM asset classes.
Remain cautious and defensive overall. Stay long DM Europe over EM Europe. Look for EM opportunities in Southeast Asia and Latin America over Greater China.
The only feasible way for Brazil to stabilize its public debt-to-GDP ratio is by having nominal GDP growth meaningfully above government borrowing costs. This requires large fiscal stimulus to boost nominal GDP and much lower interest rates. These factors will constitute the economic policy anchor of Lula’s 3.0 presidency. When markets begin to price this in, the outcome will be chronic downward pressure on the currency.
