The best Latam currency in 2010 may not be the Brazilian real

Every December my dad sends me some cash as Christmas present. And it’s always the same amount in Brazilian real. So I bear all the currency risk. Luckily in 2009, because of an incredible performance of the Brazilian real, my Christmas gift was much better than in 2008.


Last year the Brazilian real was in fact the best performing currency against the dollar. Looking forward, I think it’s very hard for the real to keep up that kind of performance. In fact, I wouldn’t be surprised if the real ends 2010 exactly where it started, trading in the 1.80- 1.70 range.


There’s another currency in Latam that may have much better potential for appreciation. I’m talking about the Mexican peso.


Brazilian real has limited near-term upside potential


The Brazilian real currency rallied by more than 32 % in 2009, the biggest advance among the 16 major currencies. This amazing appreciation of the Brazilian currency fueled imports and made the nation’s exports more expensive.

As a result, the deficit in the current account, the broadest measure for trade in goods and services, is expected to grow to record levels by the end of 2010. This trade deficit means that Brazil is buying more goods than it sells abroad (imports exceed exports).


Just like you would need credit to spend more than your income, the trade deficit requires financing by foreigners. So there’s a concern the country will become more dependent on overseas borrowing. That’s why current account deficits are generally bad for a currency.


The Government has started to taken measures to address this problem. Besides introducing a 2 % tax on foreigners’ purchases of stocks and fixed-income securities, it has also been buying dollars to try to weaken the currency.


The government has recently allowed its sovereign wealth fund to buy dollars in the foreign-exchange market to try to stem the real’s rally.


Because of this growing current account debt, the Brazilian real may just have a found a point of near-term equilibrium. Besides that, concerns about potential changes in the macroeconomic policy framework ahead of the October 2010 presidential elections should put some pressure in the real.


Mexican Peso: from underdog to outperformer


It’s not hard to understand why the Brazilian real was the best performing currency last year. After all, Latin America’s biggest economy recovered from a recession faster than most countries around the globe.

On the other hand, the Mexican peso posted a mere 4 % gain last year, becoming the second-worst performer after Argentina’s peso among the major Latin American currencies.


As you can see in the chart below, the Mexican peso (red line) has a lot of room to appreciate. The Brazilian real (blue line) has already posted a major rally, and may have little room to appreciate.


Mexican peso will try to catch up with the Brazilian real


But investors had very good reason to stay away from the Mexican peso last year. The country was plagued by political uncertainties in 2009 regarding the fiscal reform. Uncertainty about the pace of economic recovery in the US also had a negative effect on the peso because Americans still account for about 80 % of Mexican exports.


But in 2010 the Mexican peso has a lot of room to appreciate. Although the fiscal reform was far from perfect, it should generate sufficient cash flows to stabilize the debt-to-GDP ratio. That’s why the credit rating agencies maintained a stable outlook for the country after last year’s downgrades.


The economy has also been showing some signs of recovery. As an industrial economy, Mexico should do well in an environment of global manufacturing recovery. But it won’t be a walk in the park. There are a lot of uncertainties regarding the prospects of the currency. One of them is the price of oil, which is Mexico’s largest export.


If confidence in a global economic recovery fades, oil, the Mexican peso and the Brazilian real will all fall victims of rising risk aversion and consequent strengthening dollar.




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