LATAM Economies: Soft Landings, Not Recessions

Perhaps most interesting of all, the massive policy tightening cycle across Latin America’s four biggest currencies did not result in serious economic downturns despite sharply inverted yield curves that might ordinarily have signalled oncoming recessions. To be sure, growth did slow across the region but for the most part GDP growth remained in positive territory and unemployment rates did not rise substantially.

That said, there has been a great deal of variation across the region in terms of currency performance versus the U.S. dollar (USD) (Figure 2). Despite the central banks’ deft and proactive management of inflation, GDP growth and unemployment, LATAM currency spot rates have mostly fallen versus the USD. For a long while, the Mexican peso (MXN) was the exception as Mexico was attracting a great deal of foreign investment. However, following its recent elections and judicial reform, MXN has begun to weaken as well.

Banco Central do Brasil’s 1,175 basis-point (bps) tightening was among the most dramatic anywhere in the world and produced a sharp inversion of Brazil’s yield curve. That said, Brazil’s GDP growth rate has been remarkably steady (Figure 3) and unemployment has fallen to its lowest levels since 2016 (Figure 4) despite the rate hikes. Meanwhile, core inflation in Brazil has settled at around 4%, which, like most of the world, is 1-2% higher than it was in the years immediately before the pandemic (Figure 5). Overall, Brazil’s economy has been remarkably resilient thus far in the face of higher rates both at home and abroad. That said, Banco Central do Brasil did ease policy 325 bps, which may have helped stave off an economic downturn. Moreover, Brazil became the first country in the world that was recently easing policy to begin tightening again – this could be a harbinger of what happens elsewhere if economic growth remains resilient and core inflation rates don’t fall further.

Banco Central de Chile’s 1,150 bps of rate hikes sharply inverted Chile’s yield curve, which did correspond to a brief period of negative GDP growth and a very mild recession in early 2023 (Figure 6). Chile’s GDP growth rate has subsequently turned back to positive and is currently growing at a pace of 2.2% per year. Chile’s unemployment rate did not rise substantially, going from 8% to just below 9% (Figure 7). Meanwhile, Chile’s inflation rate has fallen back to 4.1% from a peak of 14.1% (Figure 8). The current pace of inflation is about 1% higher than pre-pandemic levels, a phenomenon seen in most countries outside of China. Banco Central de Chile has cut policy rates more dramatically than its peers over the past two years but the scope for further easing may be very limited and rate hikes are now a risk.

Banco Central de Colombia’s 1,150 bps of rate hikes also corresponded to a slower economic growth and a brief dip in GDP, which is now growing at a very slow pace (Figure 9). However, Colombia has not yet experienced a deep downturn. The country’s unemployment rate has steadied at around 10% (Figure 10), close to its mid-2010s lows, while core inflation has come down to around 6% (Figure 11). Unlike its peer nations, Colombia’s inflation remains much higher than the pre-pandemic level, which may limit the scope for further rate cuts.

While Mexico has benefitted from strong capital inflows owing in large part to manufacturers diversifying supply lines into the U.S. and away from China, Mexico’s GDP has grown slowly, currently at a pace of around 1.5% YoY (Figure 12). Higher rates, an inverted yield curve and a strong currency have helped to slow the pace of growth in Mexico. The strong currency, in particular, has meant that Mexico is no longer an inexpensive holiday destination as it was previously.

Slower growth in Mexico has not translated into higher unemployment, which remains at exceptionally low levels (Figure 13). Meanwhile, core inflation has crawled back to 4% YoY, one of the rare countries in which inflation has returned to pre-pandemic levels (Figure 14). Banco de Mexico has been cutting rates much more slowly than its peers, perhaps owing to the extremely tight labor market. Their reticence in cutting rates as sharply as their southern neighbors might also reflect their desire to maintain a fairly consistent spread between their rates and those of the Fed.

Since 2021, LATAM’s big four central banks have been a solid leading indicator of what is to come in the U.S., Canada and Europe. LATAM economies have slowed sharply in response to rate hikes but, thus far, have achieved what looks like soft landings rather than recessions.