Elevated Nominal Yields, Aggressive Tightening Among Strong Drivers of 'Cheap' Latam FX

• Last year, the significant rise in inflationary pressures has resulted in aggressive hikes by EM central banks (CEEMEA/ Latam).
  • Most of the effort done by EM policymakers was to limit the downside risk in the domestic currency as a depreciating currency keeps supporting inflation expectations.
• Hence, investors were curious to see in the beginning of this year if the '2021 effort’ will payoff in 2022 with EM currencies consolidating significantly higher despite Fed preparing for hiking.
• However, even though the CEEMEA and Latam central banks have continued to run an aggressive tightening cycle, the Russia/Ukraine conflict generated a sharp divergence between Latam and CEEMEA currencies (CEEMEA FX have been very sensitive to the geopolitical uncertainty).
• The bottom chart shows that CEEMEA FX have been the worst performing currencies this year among the EM world, with TRY standing at the bottom of the League (down 9.3% so far against the US Dollar).
• The CBRT is still expected to keep its benchmark rate steady at 14% this week despite inflation rate standing above 60%.
• HUF is the second worst performing currency, down 6.7% against the greenback as political uncertainty in addition to the Ukraine war have been weighing on the forint.
• On the other hand, BRL has experienced tremendous gains this year and is the best performing currency among EM, up nearly 19% against the US Dollar.
• As Latam economies have been significantly less sensitive to the Russia/Ukraine dynamics, the sharp hikes from central banks and high nominal rates have been supporting the 'cheap' FX.
• 'Momentum on 'risk-on' ZAR has also been strong since the start of the year (second best performing currency, +9.4%), mainly supported by the elevated real yields and record current account surplus.

Source: Bloomberg/MNI