Traders fear losing momentum to Latin American currencies

The hope that China more than offset the slowdown in growth elsewhere in the world is giving a boost to commodities. That, coupled with high interest rates across the region after months of intense inflation fighting, has traders fearing missing out on a rally.

The Chilean peso, the Mexican peso and the Brazilian real led gains among emerging market currencies on Tuesday, pushing year-to-date gains to at least 3.5% each. That puts them in the top five best-performing major coins this year. The Colombian peso is not far behind, advancing 2.5% even with today’s losses.

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As a major exporter of everything from oil to iron ore, Latin America will benefit from the rally in commodities sparked by China’s decision to abandon its zero COVID-19 policy. The same happened in the first quarter of 2022, when higher commodity prices boosted the terms of trade of emerging market economies, especially in the region, pushing the Brazilian real, the Chilean peso and the Colombian peso to appreciate a 18%, 8.4% and 8.2%, respectively.

This time, the move could be even stronger, as rather than face the prospect of higher US rates, traders gauge the possibility that the Federal Reserve will end its tightening cycle soon and Latin American currencies offer a big carry to serve as a buffer for bulls.

“It’s a good time to go long in Latin America,” said Guilherme Lemos, portfolio manager responsible for Latin America at XP Asset Management. “On average, the region’s central banks have done their job to rein in inflation expectations, while investors have already priced in a US terminal rate of around 5%.”

Even so, the high volatility of Latin America means that trading is restricted to traders who can withstand the ups and downs. That helps explain why the Mexican peso has been a carry trader’s favorite for over a year, offering almost the same carry as the Brazilian real with half the anticipated volatility.