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Goldman Sachs on PEN and Fitch Downgrade

PERU
  • In Q2, GS empirical work suggested that, as market perceptions of domestic risks had risen through Peru's elections, rising political risk premium had driven an historic gap between USD/PEN and its traditional drivers.
  • In recent days, the USD/PEN cross has moved more than 5% lower in sharp fashion, as a recent cabinet reshuffle has helped to moderate some investors' concerns that Peru would follow a heterodox policy path under its new president.
  • Going forward, the ultimate mix of domestic policy remains unclear: for example, while recent news has been welcomed by many market participants, much depends on the consequences of the cabinet reshuffle for the government's support in Congress, and its ability to drive a conventional policy mix.
  • What is more clear, however, is that USD/PEN likely has further room to fall if left tail risks are perceived as continuing to diminish: the updated GS empirical model suggests that—while it has unwound sharply in recent days, the amount of political risk premium priced into USD/PEN remains substantial (roughly on the order of 13% versus the USD). Should news from Peru continue to be market-friendly, the Sol is likely to continue to benefit.
  • Separately, Fitch's recent rating cut reflects the heightened policy and political uncertainty and risk. After the downgrade, Fitch rating is one notch below those of S&P and Moody's. In GS' view, if economic conditions and the policy mix were to further deteriorate, it could lead to additional negative rating actions.
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