FOMC Preview: Implications for LatAm currencies - HSBC

Recent US economic data has given markets little additional direction regarding the potential path of Fed normalization, explains the analysis team at HSBC.

Key Quotes

“Job gains appear to have slowed and consumer confidence has moderated, while there is little evidence that wage pressures are accelerating. But the unemployment rate fell to a low 4.3% in May, while the US ISM manufacturing figure indicates industrial output and employment should continue to expand over the course of this year. Core (CPI) inflation slowed further in April to 1.9% y/y, down from 2.3% in January. The FOMC minutes from May show that a rate hike at the next meeting (13-14 June) is likely.”

“With a June hike now strongly assumed by market players, there seems little chance of strong Fedinduced upward USD movements in the short term. As such, the implications of a June hike on LatAm FX should be modest, in our view. More important for currencies is the uncertainty surrounding the timing of the next rate hike after June. Since recent wage and inflation data is unlikely by itself to move the “dot plot,” we do not expect a major shift in Fed policy, keeping its guidance at 75bps per year (for 2017 and 2018). If anything, there may be a risk of the dot plot moving lower for next year due to softer inflation and wage data, which could be negative for the USD and supportive for LatAm.”

“We also expect that a change in the Fed’s reinvestment policy to reduce its balance sheet will likely not happen at the June meeting, though more details of the disinvestment policy may be communicated to financial markets. It could still start sometime this year and not next, as we previously thought, but the 19-20 September FOMC meeting is more likely, implying commencement of disinvestment in October.”

“The current Fed stance should thus be broadly supportive for LatAm assets, where yields remain attractive. If we get a more dovish tone from the Fed (not our base case view), that would precipitate a stronger rally in LatAm FX, particularly for currencies like MXN. Fundamentals have improved in places like Mexico and Brazil since the beginning of the year, but MXN remains cheap in real terms while BRL has already had a large adjustment. That said, we remain wary of idiosyncratic risks. Political developments in Brazil threaten the passage of key reforms, while following gubernatorial elections in Mexico, investor focus will once again turn to trade negotiations with the US.”