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The Macro Brief – The LatAm low-down with Joseph Incalcaterra
774 Plays20 days ago
Fresh from HSBC's inaugural Brazil Forum, Head of LatAm Macro Strategy Joseph Incalcaterra joins Aline van Duyn to discuss the macro landscape across Latin America's key economies.
Disclaimer: https://www.research.hsbc.com/R/101/NBdxbGK
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Transcript
Introduction and Podcast Overview
00:00:01
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto today's show.
00:00:24
Speaker
This is a podcast from HSBC Global Investment Research recorded for publication on Friday the 10th of October. Analyst certifications, disclosures and disclaimers must be viewed on the link attached to your media player.
Focus on Latin America: Brazil, Mexico, and Argentina
00:00:45
Speaker
Hello and welcome to The Macrobrief, where we look at the issues driving financial markets across the globe. I'm Aline Van Dyne, Global Head of Editorial and Multimedia.
00:00:55
Speaker
And this week I'm back in New York and we're taking a closer look at Latin America. Now, Brazil has been in the headlines. President Trump has been speaking to President Lula in what is reported to have been their first substantive conversation since the US imposed 50% tariffs on Brazilian goods.
00:01:14
Speaker
Mexico and the U.S. continue to be in constant dialogue about trade. In fact, next year, a review of the USMCA, which is the trade pact between Mexico, the U.S. s and Canada, is looming.
00:01:27
Speaker
In Argentina, there are questions about whether President Malay can continue with his reforms. So a lot to unpack. And to help me do that, I'm joined by Joseph in Calcaterra, our head of LATAM Macro Strategy.
Brazil's Global Forum and Trade Relations
00:01:41
Speaker
Joseph, welcome to the Macro Brief. Let's kick off with Brazil, because you were there recently. What were your takeaways? What's the mood amongst investors? So it was really interesting because we hosted our inaugural Brazil Global Forum, which was a conference that not only explored local themes such as, you know, central bank and local growth, but actually linkages between Brazil and Asia, right?
00:02:03
Speaker
And given the strong trading relationship, but also strong interest in Asian assets from local investors, I think this was quite interesting. um We had chief economist for Asia, Fred Newman was there. And um yeah, it just kind of, we see more growth actually happening in that relationship.
00:02:18
Speaker
So that's trade growth between Brazil and China? I think that's one aspect of it. You know, in the first Trump administration, we did see an increase in growth between Brazil and China. And that's probably going to happen again this time, maybe even an even more pronounced way.
00:02:31
Speaker
So this is definitely something that we're going have to keep an eye on. And it just, I think, reflects shifting patterns in in global trade. So before we get into that, let's just quickly set the scene in terms of where we are in the Brazil economy and markets.
00:02:47
Speaker
Definitely some challenges. There definitely has been some volatility, especially in the currency markets. ah There's been headlines around concerns there. Just give us a quick summary. Where are we?
00:02:59
Speaker
Yeah, so it's been a roller coaster. If you remember, 2024 ended on a very dramatic note. the The currency depreciated sharply and the central bank was forced to do very strong intervention right to defend the currency.
00:03:12
Speaker
It actually ended up being quite pivotal because not only were they able to basically put an end to to the depreciation. But thanks to like shifting local policy and political factors, actually, BRL has been one of the strongest performing currencies this year, right? So we we started the year on very dramatic terms with a depreciating currency.
00:03:31
Speaker
And this has been now one of the biggest EM m trades. And that has really defied expectations. Yeah. I would say so. I mean, we were quite bullish shot the on the BRL earlier in the year. You know, we thought that the depreciation was overdone given the fundamentals of the country, which is strong growth, ah you know, a cautious central bank with very hawkish monetary policy, political risks that we thought were manageable.
00:03:52
Speaker
So we thought it was too much. had gone too far. um And indeed, we are sitting in an area now where we can say that you know the worst has passed. And I think most of this was on the local side. you know You did see fiscal risk start to fade a little bit compared to where we were earlier in the year.
00:04:07
Speaker
And then more meaningfully, I'd say around the summer, the Northern Hemisphere summer, you did have you know some optimism about how the elections next year would go. Those assumptions have been challenged a little bit. And then you had the the tariff the tariff escalation between the US and Brazil.
00:04:22
Speaker
But now we stand in a scenario where things are normalizing a little bit. The elections are still some some ways away. 2026, right? Exactly, in October 2026. So the market tried to trade that theme and you can actually still see maybe the equity market reflects it a little bit more.
00:04:38
Speaker
But when it comes to currency markets, for example, investors are saying, look, where else do you have a 15% policy rate? um So the carry is extremely high and volatility has come down. So carry to vol ratios are high
Political Risks and Fiscal Policies in Brazil
00:04:52
Speaker
and it's a perfect carry trade. So there's actually quite a lot of optimism um towards the currency right now.
00:04:58
Speaker
There are some concerns because it's a crowded trade and we actually still do see risks with how the the politics can evolve in the coming months. But for now, there's a lot of optimism and and and the carry trade is in full force. So what are the main risks that people should be focused on ah regarding Brazil? And we can talk more broadly about the region in a minute.
00:05:17
Speaker
But is it still fiscal issues? Is it trade and tariffs? Or like, what are the main risks right now? Really, everything comes down, I think, to the elections next year. ok um That's the main factor. um and And many market participants see this at ah as a bit of a binaryary binary outcome, particularly on the fiscal side.
00:05:37
Speaker
So a lot of you know variables really relate to that. But I would say in the more immediate term, you know, you had this 50% tariff put on by the US that created some concerns, but we never thought it was, you know, extremely important for the local growth story. Trade is fairly small in Brazil as a share of GDP.
00:05:57
Speaker
There was a lot of exemptions to these tariffs. um But we do see finally some positive signals coming from the diplomatic channels, you know, President Trump and Lula met during the UN. They're scheduling a meet. They had a phone call the other day that went well and they're they're scheduling an in-person meeting. So things have even changed on that front quite rapidly. Yeah, yeah, yeah. A lot of rapidly changing headlines really related to this.
00:06:19
Speaker
Exactly. So that's been helping sentiment a little bit. And, um you know, for the the rest of this year, we think the fiscal concerns are going to take the back seat. You know, the fiscal accounts look okay But really, it's probably going to be early 2026 where the market starts to play out, you know, scenarios for the election. Yeah. And if it's perceived that President Lula's approval rating is going up, if he's gaining more support, the market could see that as something, you know, as ah as as as a source of volatility. Yeah.
00:06:48
Speaker
um And especially given that, you know, the fiscal accounts next year will be in a lot more focus and the government will probably have to make cuts to meet the fiscal rule. They might be reticent to do that. So you could see how these factors would come together to spark volatility. so So in some ways, the fiscal pressures are a slightly on the back burner, but they're going to rise the fore next year. And then that becomes more of an issue, especially with the potential for policy change post-election.
00:07:13
Speaker
Exactly. On the back burner for now, which, let's say, opens up a little bit of
Mexico's Trade Resilience amid US Tariff Concerns
00:07:17
Speaker
runway for BRL to remain somewhat strong. But next year, not only will we have the near-term fiscal concerns of, you know, is the government meeting the fiscal rule? Are they matching the accounts?
00:07:26
Speaker
Then also longer-term fiscal concerns, meaning, you know, are we going to see any change in the overall fiscal management of this country? And that, for many investors, is seen as kind of an existential concern for Brazil, given that the GDP close to 80%, you know, yeah policy rate of 15%, the debt dynamics are a bit unsustainable. Yeah, and to be honest, it feels like we have had that conversation many times before, right? So it's a recurring issue, a recurring risk, and it will be be at the forefront next year.
00:07:57
Speaker
Exactly, and investors are hoping that, you know, the elections could allow for a change in the overall fiscal regime. So to the extent that that doesn't happen or that appears that that might not happen, That would be a warning signal for local assets. Yeah, interesting.
00:08:09
Speaker
Now, one thing you said is just that Brazil's economy is not as tight a trade. It's obviously relatively closed economy compared to the other big economy in the region, Mexico.
00:08:21
Speaker
So let's switch our attention to that. Presumably, trade tariffs have been having a bigger impact? Or again, has that surprised a bit in terms of resilience to to some of these headwinds?
00:08:34
Speaker
Yeah, it's been actually a positive a massive positive surprise because currently Mexico has some of the lowest effective tariff rates in the United States. That's mostly because USMCA remains in effect. I mean, taking a step back, we came into this year expecting the worst for Mexico, right? He was talking about you know tariffs on Mexico even before he assumed the presidency. and And this also, to put it in perspective, comes after a very difficult year for Mexico with elections that, you know, went the way investors weren't expecting, the judicial reform that was seen as hitting, you know, the the structure of the economy yeah or the political system.
00:09:06
Speaker
It seems like really this year started with a lot of concern across the region. I mean, you just described Brazil, the the currency pressures there, now Mexico. The beginning of the year followed ah really tough 2024.
00:09:20
Speaker
Yeah, big concerns in Colombia as well, and you know with the fiscal situation there. you know in Chile, you had a ah more uncertain growth outlook, let's say, and and the threat of copper tariffs coming through and and numerous factors. So yeah, and we were we were it was a very nervous situation for lot time earlier this year. And now fast forwarding to where we are now, a lot of those risks have actually cleared and growth is actually holding up okay.
Latin America's Market and Election Impacts
00:09:43
Speaker
um Maybe the disinflation trend hasn't been as linear as we would like, but central banks are are taking that into account. So, yeah, I would say that a lot of those risks have have cleared up. and And going back to your point on Mexico, um you know, really managing the trade relationship with the United States, you know, striking that right balance, preserving USMCA.
00:10:02
Speaker
So we're currently in a scenario where investors, um I would say, are are are quite comfortable with Mexico. They see the risks of being very limited. um The growth has been weak. you know We did see a ah sharp deceleration in activity this year.
00:10:16
Speaker
Part of that is related to this trade uncertainty because you know as long as there's question marks about USMCA, that does hit investment. Of course. yeah But I would say that you know our you know the forecast for Mexico has actually come in or the growth has come in a lot better than some of the the more dire forecasts from you know some of our competitors earlier this year, which which didn't materialize.
00:10:38
Speaker
And Joseph, looking at this in the global context, because of course that's something that we're always doing as a team, as a department, where does LATAM sit in the emerging market landscape? Because a couple of years ago, especially on the currency side, it was like a regular outperformer.
00:10:54
Speaker
Then last year, slightly opposite story. This year, is it doing better than other emerging markets? Is it in line? Where does it sit? Yeah, I would say lately we have seen broad-based LATAM outperformance across asset classes. You see it in the FX space, especially the high-yielders. So BRL, MXN, the Colombian Peso, all three currencies have done extremely well. They're high-yielders.
00:11:21
Speaker
um Volatility has come down. you know These lower policy risks um really matter. um So yeah, I think you know it's been a very strong um a few months.
00:11:33
Speaker
I mean, now it's not just Brazil where we have elections. We're going to have elections in Chile in November, in Colombia and Peru in the first half of next year, and then of course Brazil later in the year.
00:11:44
Speaker
But I would say that, you know, for most of these elections, investors are assuming, let's say, relatively market-friendly outcomes. And I think this is front and center in Chile, where we have the elections coming up, the first round on November 16th, very high likelihood. of a change in government.
00:12:02
Speaker
And that would have, you know, pretty important implications, I think, for for growth and for just overall sentiment towards Chile. So likelihood in terms of what the polls are indicating, that there is likely to be a ah different administration elected, a different party elected, and there would be the introduction of more ah conservative economic policies. Is that the expectation?
00:12:26
Speaker
Yeah, I think so. I mean, Chile's coming out of ah of a left-wing administration, which you know actually has generally been putting forward quite ah moderate policies. But what we're seeing in the election polling is Antonio Kast with over 70% probability of winning, according to Polymarket.
00:12:44
Speaker
um And polls are telling us, I think, a a similar situation. So, you know, if you look at his policy proposals, it's all about fiscal consolidation. So maintaining a low debt to GDP ratio, which investors always like, ah deregulation, particularly on on the permits for for FDI and mining, which is an important part of the economy.
00:13:04
Speaker
So strictly from how market participants are looking at this, these are generally pro-investment policies, pro-growth policies. um So the market is is happy with that. I don't think it's reflected in the FX market, actually, because anything, the Chilean Peso is a low-yielding currency. So in an environment where we are right now, which is all about yield and carry, CLP doesn't really screen as very attractive.
00:13:28
Speaker
But I think the argument for Chile is more of a re-rating story. If you look at FX valuation metrics, which are a bit theoretical, we acknowledge that, but it does suggest that the COP is very weak. And in particular, I don't think it reflects what we're seeing in terms of trade, which is fairly high copper prices, right? Even with the volatility from tariffs, copper prices surged and then collapsed, they're still well above where they were last year,
00:13:51
Speaker
Oil prices are lower. Chile is a massive exporter of copper, massive importer of oil. So that copper oil ratio really matters. And I just don't think CLP reflects these terms of trade. So Joseph, another question, ah sort of broadening the perspective out again, how closely linked is that the outlook for Latin America to what's happening in the US? I mean, there's a lot of uncertainty there too, obviously.
00:14:17
Speaker
um And with these elections coming up in LATAM, with the relative resilience in the last six months, especially,
00:14:28
Speaker
How important do you think developments in the U.S. are for the outlook, or is there a little bit of separation? I think it does matter. I mean, historically, Mexico and the United States, for example, have always had a very tight relationship because of remittances, financial flows, investment flows, trade flows.
00:14:46
Speaker
Colombia has has a strong trade relationship, historically a free trade agreement, also remittances. um The rest of the South America somewhat less tight United States, more to China. But what I will say is that the U.S.
US Influence in Latin America
00:15:00
Speaker
is showing much more interest in Latin America as a whole compared to before this administration.
00:15:06
Speaker
um You know, you see that with Marco Rubio as the Secretary of State. um You know, the U.S. is taking a much, I think, stronger, is focusing a lot more on Western hemise western Hemisphere affairs.
00:15:18
Speaker
You see that with what's happening in the Caribbean with kind of some of these um anti-drug policies and, of course, immigration policies in the United States. You also see this with economic relations. So, you know, the tariffs between the United States and Brazil. If you look then at, you know, United States support for Argentina, which is tremendous, right? $20 billion dollars of stated support.
00:15:38
Speaker
You know, this is the last time this was done was Mexico in the 1990s after the tequila crisis. So these are are very kind of assertive policies, you know.
Argentina's Reform Agenda and Political Challenges
00:15:50
Speaker
So what happens in the United States does matter. I think the immigration policies are going to continue matter. um And ah yeah, so I think this is going to be something that we're have to continue focusing on. So look, let's end with a quick update on where we are with Argentina.
00:16:07
Speaker
What's our house view? What are our expectations there? So I think the overall um you know reform agenda remains in place. you know President Malay is going to continue trying for fiscal consolidation, bringing down inflation and a gradual relaxation of kind of some of the capital controls that are in the country.
00:16:25
Speaker
But you know the elections in Buenos Aires that happened in September were a negative shock to this story. And there are parts of the market now that are starting to consider you know a scenario where um there it would be a change of government eventually.
00:16:39
Speaker
and that milleye wouldn't be able President Millet wouldn't be able to finish his reform agenda. So I think what happened away from the United States, that's a lifeline that buys them a little bit more time. But ultimately, President Millet needs to turn around his political situation, right?
00:16:54
Speaker
He needs to get more support. And perhaps this was a wake up call that, you know, he needs to change some of the policies. But I do think the overall reform trajectory will remain in place.
00:17:06
Speaker
But let's just say the risks to this have increased quite
Stability and Risks in Latin America
00:17:09
Speaker
substantially. so So it sounds like the next few months could be a period of relative sort of stability opportunity in the region.
00:17:20
Speaker
ah Some strength in in Brazil, in Mexico, but elections and political risks are looming. Exactly. I think we're generally positive on on the region, but I think there's actually quite a bit of volatility that could come through in the next few months. In the case of Mexico, it's all going to be about USMCA.
00:17:38
Speaker
They've done everything well until now, but you know trump President Trump is talking about renegotiation of USMCA or potentially even breaking it down into different agreements. not being one together with North America, which hits at that kind of North American integration story.
00:17:53
Speaker
In the case of Brazil, I think, you know, depending on how polling evolves and and fiscal risk next year, we could see some some change in sentiment, actually. um So even though I think we're fundamentally positive on the region over the medium term, I think there are going to be some sources of volatility in the next few months.
00:18:11
Speaker
so We're keeping that positive fundamental view, but being aware of of sources of volatility and risk in the near term.
Closing Remarks and Global Research Invitation
00:18:18
Speaker
Well, Joseph, thank you for the update. It sounds like we'll have lots more to talk about in the coming months. So hopefully we'll have you back for for some updates in Latin America. and Thank you. Thanks for having me and I'd love to be back.
00:18:40
Speaker
Now, before we go, a reminder that at HSBC Global Investment Research, we cover economies across the globe. Latin America is, of course, not the only region where politics and policies are in the spotlight.
00:18:54
Speaker
Check out our reports on a new era in Japan after a new Liberal Democratic Party leader was elected and she's likely to become Japan's next prime minister. That's Sanei Takaichi.
00:19:07
Speaker
She has in the past supported expansionary monetary and fiscal policies and we expect a period of policy uncertainty ahead. Uncertainty is also high in France after the Prime Minister there resigned, making it even less likely that a budget will be voted on by the end of the year.
00:19:23
Speaker
And in the US, the government shutdown continues. To lots to analyze, please check out our website for more. And if you have any questions or comments about anything we've talked about, please email us at askresearch at hsbc.com.
00:19:39
Speaker
Don't forget to like us and subscribe to The Macro Brief wherever you get your podcasts. Until next time, thanks very much for joining us here on The Macro Brief.
00:20:10
Speaker
Thank you for joining us at HSBC Global Viewpoint. We hope you enjoyed the discussion. Make sure you're subscribed to stay up to date with new episodes.