BNY’s Geoff Yu says Latin American currencies remain relatively resilient even as iFlow data show declining positions in high-yielders under a new Federal Reserve backdrop. He stresses that improved terms of trade, especially for Brazil and Chile, help offset rising Dollar preference, but warns that attracting fresh inflows may require more hawkish policy from regional central banks to maintain supportive real rates.

Exports and carry support regional currencies

"Our iFlow Carry indicator is pointing to declines in holdings in high-yielding currencies, and the process is likely to continue as markets adjust to a new Fed reality. Even so, we continue to distinguish between a steady reduction in carry holdings – the situation at present – and outright liquidation. LatAm currencies are the most resilient group in this context, but transmission of Fed rates is swift into the region, while political developments are also influencing investment flows, in both directions."

"That said, we shouldn’t discount the positive terms-of-trade shock to the region. For the likes of Brazil and Chile, export values have risen to multi-year highs due to the conflict and other structural factors (Exhibit 3). In contrast to much of Asia, these natural flows will help offset the rise in global dollar preference, but central banks will need to stay vigilant and ensure real rates adjust to new Fed dynamics."

"Rate decisions in Peru, Chile and Brazil over the next trading week should not yield any major surprises, but LatAm currencies will need to monitor elevated short-term dollar preference. USD rates aside, the need to generate dollar liquidity to fund share sales and U.S.-market offerings remains high, and the market may move toward higher-hanging fruits."

"In FX markets, LatAm carry trades and fixed income positions are the last expression of “risk-on”, particularly as cross-border dollar hedges have fully unwound the excess short positions built before the conflict. Yields and the policy outlook are now only sufficient to limit large-scale liquidation."

"But if the aim is to attract fresh inflows to ease onshore financial conditions, policy decisions may need to lean more hawkish."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)