Though global investors often overlook them, Latin America’s central banks have been the global leaders when it comes to setting interest rates so far this decade. Unlike the Federal Reserve (Fed), the European Central Bank (ECB) and other Northern Hemisphere central banks, which were slow to react to the 2021-2023 inflation surge, ttheir Latin American counterparts sprang into action up to a year ahead of their peers. They are once again taking the lead. This time, Latin American central banks’ 2021-22 policy tightening wave is giving way to loosening, with Brazil, Chile and Colombia already cutting rates (Figure 1). Bank of Mexico is the lone holdout thus far.
Figure 1: Latin America’s central banks led the tightening wave and now may be leading the easing
Among Latin America’s currencies, the Mexican peso (MXN) has been the outperformer, rallying against the U.S. dollar even as most others have sagged (Figure 2). Mexico’s economy is very different that of Brazil, Chile or Colombia. The latter three rely heavily on commodities for their exports. Manufactured goods account for only 16% of Brazil’s exports, 2% of Chile’s and 4% of Colombia’s compared to 71% of Mexico’s. Mexico has been one of the chief beneficiaries of U.S. attempts to onshore and nearshore production and to reduce its reliance on China when it comes to intermediate and finished products. As such, while currencies such as the Brazilian real (BRL), have fallen with commodity prices in recent years, MXN has been strengthening as a result of strong investment flows.
Figure 2: MXN has benefited from capital inflows as the U.S. begins nearshoring production
It’s not clear, however, that things are going to turn out as smoothly for Mexico in 2024. All four Latin American yield curves inverted sharply in 2022 as higher short-term rates drove expectations of an economic downturn (Figure 3). Indeed, Chile spent much of 2023 with mildly negative year-on-year GDP growth (Figure 4), and Colombia recently followed Chile into recession (Figure 5).
Figure 3: Latin American yield curves have inverted, a possible harbinger of economic weakness
Figure 4: Chile experienced a mild recession in
Figure 5: Colombia’s economy was showing negative GDP growth by Q3 2023
For the moment, Brazil and Mexico have avoided a recession, but Mexico now has the most steeply inverted yield curve in the region (Figure 3). While the Mexican economy is still growing at a pace of over 3% yearonyear (Figure 6), short-term interest rates from 4% to 11% could slow down the pace of growth. Historically, Mexico’s economy has responded to changes in the shape of the yield curve with a lag of about slower than Brazil and Colombia.
Figure 6: Mexico’s economy has resisted a downturn thus far
One reason why Mexico has resisted the impact of higher rates so much better than the rest of Latin Americarelated to its lower levels of debt. Mexico’s total level of public and private sector debt comes in at 75% of GDP, much lower than Colombia (112%), Brazil (159%) or Chile 171%the U.S., Canada, eurozone U.K. are closer to 250%. government debt 40% of GDP, household debt at 16% of GDP and non-financial corporate debt at only 21.5% means that higher rates and an inverted domestic yield curve may be of little consequence to Mexican consumers and businesses (Figure 7).
Figure 7: Mexico has far less debt than its peers, perhaps making its economy less rate-sensitive
Of course, Latin American countries aren’t the only ones who have inverted yield curves. The U.S. and Canada, to which Mexico sends nearly 80% of its exports, also have inverted yield curves. The U.S. and Canadian economies typically take years to respond to monetary policy tightening. As such, the full impact of the Fed and Bank of Canada tightening cycles is unlikely to be felt until later in 2024 or even in 2025. Should Mexico’s main trading partners have an economic downturn as a result of their most dramatic policy tightening since 1981, that could likely be bad news for MXN, but decidedly less of a concern for the rest of Latin America. Colombia does 29% of its trade with the U.S. and Canada, Chile 17% and Brazil 12%.
These other three countries rely to a much greater degree on trade China, which has been growing at a slower-than-usual pace over the past several years, plagued by COVID lockdowns in 2022 and a declining real estate sector in 2023. Mexico does only 2% of its trade with China.
Brazil has much higher debt ratios: 85% government debt to GDP, 31.6% for the household sector and 51.1% for non-financial corporates. Despite Brazil’s comparatively elevated levels of debt and the magnitude of Brazil’s rate hikes, the country is still showing 1.9% YoY GDP growth (Figure 8). Brazil experienced a deep recession from 2014-17 followed by a slow, uneven recovery. Whether that downturn immunized it from a potential downturn to come remains to be seen. How its economy performs in 2024 will depend upon how it responds to higher rates domestically and abroad as well as to external demand conditions for its key exports, especially in China.
Figure 8: Brazil’s economy resisted recession in 2023 but experienced a downturn from 2014-17
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All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
