19 November 2019 Global Sales and Trading personnel at Macquarie are not independent and, therefore, the information herein may be subject to certain conflicts of interest, and may have been shared with other parties prior to publication. Note: To the extent Macquarie Research is referenced, it is identified as such and the associated disclaimers are included in the published research report. Please refer to the important disclosures www.macquarie.com/salesandtradingdisclaimer. FX AND RATES Fed's Broad Dollar Index Source: Bloomberg, Fed, Macquarie Strategy Strategists Macquarie Bank Limited Singapore Branch Gareth Berry +65 6601 0348 [email protected]Macquarie Futures USA LLC Thierry Wizman +1 212 231 2082 [email protected]Macquarie Bank Limited Hong Kong Branch Trang Thuy Le +852 3922 2113 [email protected]Macquarie Capital (Europe) Limited Eimear Daly +44 20 3037 4802 [email protected]This publication has been prepared by Sales and Trading personnel at Macquarie and is not a product of the Macquarie Research Department. Global FX Outlook: Peak USD Topping out For the US dollar, this is as good as it gets. This is the high-water mark. A “phase one” US-China trade deal looks possible, which could end the 5-year old US dollar rally. The precise timing of any negotiating breakthrough is unknown. But even the absence of further escalation could encourage a gentle uptick in global growth and a decline in safe-haven demand. That should prevent further USD upside and even spark a very gradual decline. Escalating US political risk much later in 2020 could add to the selling pressure, especially in USDJPY which could dip to 102 by end-2020. USDCNY is likely to fall to 6.80 by mid-2020, promoting generalised USD weakness across Asia-Pacific; KRW and TWD are best placed to benefit. Any AUDUSD upswing should stop at 0.71 though. The RBA’s easing bias remains in place and each additional cut from here brings QE potentially closer. The novelty of unconventional policy, even just the distant threat of it, should help cap any gains. The outlook for GBP hinges on the UK general election, scheduled for December 12 th . A stable overall majority for Boris Johnson would trigger a decent move higher in GBPUSD, towards 1.35 by end-2020. It would also contribute to a weaker dollar, irrespective of US-China developments. A recovery in Eurozone PMIs should help EURUSD mount a tentative rebound towards 1.15 by end-2020, driven by a thaw in trade tensions at home and abroad. But the threat of US Section 232 auto tariffs is likely to linger. The potential exists for a more powerful euro upswing, but we’d be surprised if it happens. Large scale eurozone fiscal stimulus or a hawkish ECB reset both seem unlikely. An epic rebalancing out of US stocks and into Eurozone equities is just about conceivable, given real money positioning is lop-sided. But a spontaneous recovery in European growth seems very unlikely, so the trigger for such a move would have to originate inside the US and selectively cripple the US growth outlook. Outside of extreme US political developments, it’s hard to imagine what might provide the necessary spark. The Canadian dollar should be an exception in the developed-market space, bucking the weaker USD trend. USDCAD could climb to 1.35 by end-Q1 as poorer data catches policymakers out, and the BoC is finally forced into a long- awaited easing cycle. We are constructive on RUB. But ZAR is likely to be left behind in any EM rally, potentially falling to 15.55 against the USD by end-2020. The Asian high-yielders (IDR and INR) could also struggle as global bond yields push higher and the Fed refrains from further cuts. The outlook for BRL, MXN and CLP looks equally challenging. 90 95 100 105 110 115 120 125 130 135 Jan-95 Jan-03 Jan-11 Jan-19 index
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19 November 2019 Global
Sales and Trading personnel at Macquarie are not independent and, therefore, the information herein may be subject to certain conflicts of interest, and may have been shared with other parties prior to publication. Note: To the extent Macquarie Research is referenced, it is identified as such and the associated disclaimers are included in the published research report. Please refer to the important disclosures www.macquarie.com/salesandtradingdisclaimer.
This publication has been prepared by Sales and Trading personnel at Macquarie
and is not a product of the Macquarie Research Department.
Global FX Outlook: Peak USD Topping out
For the US dollar, this is as good as it gets. This is the high-water mark. A “phase
one” US-China trade deal looks possible, which could end the 5-year old US
dollar rally.
The precise timing of any negotiating breakthrough is unknown. But even the
absence of further escalation could encourage a gentle uptick in global growth
and a decline in safe-haven demand.
That should prevent further USD upside and even spark a very gradual decline.
Escalating US political risk much later in 2020 could add to the selling
pressure, especially in USDJPY which could dip to 102 by end-2020.
USDCNY is likely to fall to 6.80 by mid-2020, promoting generalised USD
weakness across Asia-Pacific; KRW and TWD are best placed to benefit.
Any AUDUSD upswing should stop at 0.71 though. The RBA’s easing bias
remains in place and each additional cut from here brings QE potentially closer.
The novelty of unconventional policy, even just the distant threat of it, should help
cap any gains.
The outlook for GBP hinges on the UK general election, scheduled for
December 12th. A stable overall majority for Boris Johnson would trigger a decent
move higher in GBPUSD, towards 1.35 by end-2020. It would also contribute
to a weaker dollar, irrespective of US-China developments.
A recovery in Eurozone PMIs should help EURUSD mount a tentative rebound
towards 1.15 by end-2020, driven by a thaw in trade tensions at home and
abroad. But the threat of US Section 232 auto tariffs is likely to linger.
The potential exists for a more powerful euro upswing, but we’d be surprised
if it happens. Large scale eurozone fiscal stimulus or a hawkish ECB reset both
seem unlikely.
An epic rebalancing out of US stocks and into Eurozone equities is just about
conceivable, given real money positioning is lop-sided. But a spontaneous
recovery in European growth seems very unlikely, so the trigger for such a move
would have to originate inside the US and selectively cripple the US growth
outlook. Outside of extreme US political developments, it’s hard to imagine what
might provide the necessary spark.
The Canadian dollar should be an exception in the developed-market space,
bucking the weaker USD trend. USDCAD could climb to 1.35 by end-Q1 as
poorer data catches policymakers out, and the BoC is finally forced into a long-
awaited easing cycle.
We are constructive on RUB. But ZAR is likely to be left behind in any EM rally,
potentially falling to 15.55 against the USD by end-2020. The Asian high-yielders
(IDR and INR) could also struggle as global bond yields push higher and the Fed
refrains from further cuts. The outlook for BRL, MXN and CLP looks equally
challenging.
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Global FX Outlook: Peak USD
19 November 2019 2
Contents
Forecast Summary ................................................................................ Error! Bookmark not defined. USD: Peak US dollar has arrived .......................................................................................................... 7 CNY: On recovery track ........................................................................................................................ 9 EUR: Basing at last ............................................................................................................................. 12 AUD, NZD: The allure of unconventional measures .......................................................................... 14 GBP: A relief rally ................................................................................................................................ 17 JPY: Rally on hold ............................................................................................................................... 19 CAD: Rates Cuts Will Undermine the Loonie’s Strength ..................................................................... 20 EM FX Asia: A change of fortune ....................................................................................................... 22 EMEA: The risk-reward weighing scales ............................................................................................. 26 Latin America: Will Politics Drive Performance in 2020? ................................................................... 31 Detailed FX Forecasts Table ............................................................................................................... 44
Global FX Outlook: Peak USD
19 November 2019 3
Forecast Summary
Fig 1 Major currency FX forecasts summary
Spot Forecasts*
Currency vs. Latest 19Q4 20Q1 Near-term view
US dollar EUR 1.106 1.090 1.110 Mildly bearish for 2020. A mini-global growth upswing should benefit other more-open economies proportionately more than the US. It should also undermine the dollar’s safe haven appeal. Escalating US political risk could add to the USD selling pressure later in 2020, but we would not want to overstate the case. While the policies of some presidential candidates might not be market-friendly President Trump’s counter-manifesto could keep USD bulls engaged.
by market convention JPY 108.8 109.0 109.0
GBP 1.293 1.300 1.300
AUD 0.682 0.690 0.700
CNY 7.01 6.95 6.85
Euro USD 1.106 1.090 1.110 Getting mildly bullish. EURUSD is well placed to benefit from a gentle global growth upswing, plus an amical Brexit resolution. But FX technical resistance might not be overcome, at the earliest, until the UK’s general election is out of the way on Dec 12th. Escalating US political risk should add to upside pressure later in 2020.
Foreign currency units per euro JPY 120.3 118.8 121.0
GBP 0.856 0.838 0.854
AUD 1.622 1.580 1.586
CNY 7.75 7.58 7.60
Japanese yen USD 108.8 109.0 109.0 Neutral for now. The global economic backdrop looks set to brighten after the recent scare. The Fed seems in no rush to cut again either, which suggests this could be just a mid-cycle adjustment rather than the early stages of a deeper easing campaign. Neither development is good for the yen. But a delayed yen rally still looks likely, as US political risks intensify into the US Presidential Election.
Yen per unit of foreign currency EUR 120.3 118.8 121.0
GBP 140.6 141.7 141.7
AUD 74.2 75.2 76.3
CNY 15.5 15.7 15.9
UK sterling USD 1.293 1.300 1.300 Bullish. ‘Hard Brexit’ risk should recede materially if PM Johnson returns as PM with an overall majority after the upcoming general election. Opinion polls are pointing convincingly in that direction. His new Brexit withdrawal deal could then be ratified, offering a route out of the quicksand. The issue of how to handle the end of the transition period in Dec 2020 would remain unresolved, but at least the tail-risk of a hard no-deal exit would have mostly vanished, ensuring GBP holds on to recent gains and creeps even higher. that depends on Brexit Party and DUP support. There would be very limited room for manoeuvre in that case, raising the risk of a hard no-deal Brexit whenever the clock runs out again, probably sometime in Q1 2020. A thumping overall majority though, however unlikely, would create scope for compromise, in which case.
Foreign currency units per pound EUR 1.169 1.193 1.171
JPY 140.6 141.7 141.7
AUD 1.896 1.884 1.857
CNY 9.06 9.04 8.91
Australian dollar USD 0.682 0.690 0.700 Mildly bullish for now in anticipation of a partial US-China trade deal being struck. This would deliver a shot in the arm for global growth and boost CNY too (dragging AUD along for the ride). But any additional RBA rate cut from here brings closer the day when unconventional measures might be needed. Although we see no imminent risk of this, the market is likely to price in QE well in advance, which — for AUD — should more than neutralise the benefit from any trade resolution.
Foreign currency units per dollar EUR 0.616 0.633 0.631
JPY 74.2 75.2 76.3
GBP 0.527 0.531 0.538
CNY 4.78 4.80 4.80
Chinese renminbi USD 7.01 6.95 6.85 Bullish: Our base case is for a Phase 1 deal to be signed before December 15 to enable 4Q tariff cancelation. A currency agreement in trade deal combined with a step up in China stimulus we forecast by 1Q 2020 and a gentle global growth rebound will support RMB strength in 1H 2020. The PBoC is likely to encourage CNY appreciation post deal via lower USDCNY fixes. A rollback of the September tariffs would be an upside versus our base case, while a delay in Phase-1 deal beyond December represents a downside risk.
RMB per unit of foreign currency EUR 7.75 7.58 7.60
Canadian dollar USD 1.322 1.34 1.35 Bearish. The BoC’s unwillingness to follow the Fed into dovishness has kept the CAD strong vs. the USD. But we see this policy strategy shifting as poorer data catches up with policymakers. We foresee the beginning of an easing cycle in Q1 2020, underpinning the CAD’s softness.
New Zealand dollar† USD 0.640 0.64 0.65 Neutral, but likely to underperform AUD. RBNZ Gov Orr is already talking about the theoretical possibility of unconventional measures, and even appears to have settled on negative rates as his preferred tool. Looks like the RBNZ may reach the unconventional threshold before the RBA does.
Indonesian rupiah USD 14072 14150 14050 Neutral: Global environment has turned less favourable for IDR with a rise in global bond yields, and a Fed pause, while domestically inflation is trending higher. Similar to RBI, the scope for BI to cut rates further should be limited, although fiscal concern is less severe in Indo case versus India.
Indian rupee USD 71.8 71.5 71.2 Underperformance near term. Weak growth and fiscal slippage remain key concerns amongst investors. While RBI may still cut in December, a Fed pause and an uptick in food inflation could limit its ability to ease further, denting sentiment. A focus on improving transmission of rate cuts to market rates could improve INR outlook in 2H 2020. FDI inflows could surprise to the upside thanks to the recent corporate tax cut and FDI incentives.
Taiwan dollar USD 30.5 30.3 29.8 Bullish. TWD will benefit from a rebound in tech cycle driven by smartphone and data-center growth, although to a lesser degree than Korea given its product mix. Lifers have increased TWD hedges in the past months, but we believe hedging ratios still remain below levels in 2017/18. This implies need for lifers to chase TWD on strength if and when US-China trade deal is finalized.
Korean won USD 1163 1160 1130 Outperformance: KRW outperformance is
supported by its high “beta” proxy to global growth, a return of equity inflows (which have lagged others in the region YTD), and a bottoming in the memory price cycle and tech demand. The BoK may still cut once in in 1Q 2020, but FX correlation with equity has tended to overwhelm rate spreads. Legislative elections in April 2020 a risk to watch for the won.
Malaysian ringgit USD 4.15 4.18 4.20 Underperformance. MYR should normally benefit from a rebound in global growth, while the recent surge in palm prices also implied better terms of trade support. However, we suspect the pending FTSE Russell decision on Malaysia’s bonds exclusion from its flagship WGBI index will still weigh on sentiment, limiting foreign inflows and capping MYR performance relative to its peers in 1H 2020.
Singaporean dollar USD 1.361 1.360 1.350 Neutral. USDSGD path should be largely a function of the broad USD weakness we expect over the coming months. Good news are otherwise already in price when it comes to the NEER as it trades close to the top-end of its policy range. We
Global FX Outlook: Peak USD
19 November 2019 5
view SGD as a funder for relative value trades in Asia near term.
Philippines peso USD 50.62 50.8 50.0 Neutral. PHP is likely to drop from the top 3 in the EM Asia FX ranking table this year to the middle of the pack in 2020. PHP strength in 2019 was a result of a recovery from an inflation and growth shock in 2018, supportive real rates, and lower current account deficit due to delayed Budget spending. These tailwinds could turn into headwinds in 2020, with the current account deficit likely re-widening while inflation should tick up from a low base.
Argentinian peso USD 59.7 63.0 69.0
Neutral. FX controls have made price discovery in the USD/ARS impossible, but the FX controls are likely to endure for many several quarters, and at least until the new gov’t can conclude its negotiations with bondholders and re-establish access to int’l capital markets. How the new gov’t will treat bondholders will reflect on the coherence of its domestic policies in regard to the needed fiscal adjustment and a resumption of ‘normality’.
Brazilian real USD 4.19 4.25 4.30 Bearish Short-term, More Constructive in 2020. Pressure from the weaker ARS and the BCB’s weak-BRL policy bias will take USD/BRL higher before it stabilizes around 4.25, before reform initiatives help support sentiment and the BRL stabilizes by early 2020.
Chilean peso USD 777 790 810 Relatively Bearish. The prospect that a new constitution will be drafted over the next 9- to 12 months ensures that uncertainty about Chile will remain high throughout 2020. After the BCCh’s measure help stabilize the CLP in the short term, expect depreciation to resume during 2020.
Colombian peso USD 3426 3400 3400 Relatively Bullish. Relative to the region, Colombia has been a growth ‘champ’, although we doubt that strong growth will persist in absolute terms into H2 2019, especially as residential investment slows. Policy rates throughout most of 2020 will still be attractive, and the COP’s diversification properties and its detachment from China will draw organic inflows. The risk comes from labor unrest in the medium term.
Mexican peso USD 19.2 19.5 20.0 Structurally Bearish. Despite Mexico being in an industrial “slow-growth” trap, we have yet to see an earnest change of policy direction from the AMO administration, leading us to think that the risk is rising that various policy targets go unmet. Banxico remains the last bastion of conservatism, but even it will be gradually cutting the policy rate in 2020.
Turkish lira USD 5.72 5.7 5.5 Bullish. A restored positive growth differential and a global reach for yield into 2020 underpin our cautiously constructive view on the TRY. Domestic dollarization also appears to have reached a peak, removing one key driver of TRY weakness. Positioning is also cleaner.
South African rand USD 14.8 14.7 15.8 Relatively Bearish. The combination of low growth, structural barriers to economic reform, high and inexorable rising debt, immediate credit
Global FX Outlook: Peak USD
19 November 2019 6
Fig 3 USD strength prevailing against most FX counterparts into year-end
Source: Bloomberg, Macquarie Strategy.
rating risk and a relatively hawkish central banks means ZAR will be left out of the EM rally in 2020.
Russian ruble USD 63.8 63.0 60.0
Bullish. We are constructive on the RUB due to
our expectation of a stronger EUR into 2020,
fiscal loosening extending the RUB’s relative
growth differential, further CBR rate cuts driving
foreign inflows into OFZ’s and still high real yield
relative to other EMs.
Source: Bloomberg, Macquarie Strategy. *Currencies are quoted as domestic currency per US dollar unless otherwise specified († denotes inverse quotation). **End-of-quarter forecasts.
Global FX Outlook: Peak USD
19 November 2019 7
USD: Peak US dollar has arrived
The dollar’s demise has been frequently foretold ever since its rally began 5 years ago. Perhaps
the soft USD during the BRICs era has left its mark on the psyche. Same goes for the long years
of Fed QE. Both episodes have planted the idea that the dollar’s natural state is one of
weakness.
We have no wish to fall into this trap. But even we must acknowledge that the balance of risks
for 2020 is skewed towards a mildly softer outcome. For the dollar, the situation right now is as
good as it gets. This is the high-water mark.
From here a gentle pickup in global growth seems likely, conditional on a meaningful de-escalation
of US-China trade tensions. That should undermine one veneer of dollar strength: its safe
haven appeal.
It should have other consequences too. US growth would participate in that upswing, but other
more-open economies would benefit proportionately more, especially the Eurozone where the
growth effect would be amplified by relief over the avoidance of a hard Brexit. A EURUSD
upswing could soon be underway.
A trade-truce-inspired CNY surge would also spread USD weakness across the currencies of
Asia-Pacific. Meanwhile, the result of the UK general election has every chance of jolting
GBPUSD into a higher range. Combined, the price action would reinforce the sense that the USD
had turned.
Timing the turnaround will be tricky as much hinges on how long it takes to seal a partial US-
China trade compromise. Suffice it to say that the US political calendar means we are talking
weeks or months, not years.
Fig 4 Equity market performance (USD terms) Fig 5 Foreigners are active in US stocks
TRY: Turkish delight for those with a strong stomach
Fig 44 Sharp reduction in Turkish banks’ loan to deposit ratio
Fig 45 Bank credit is picking up
Source: Turkey Banking Regulation and Supervision Agency, Nov-2019 Source: Turkey Banking Regulation and Supervision Agency, Nov 2019
Fig 6 Domestic Dollarization looks exhausted
Fig 47 Substanial easing in financial conditions
Source: Bloomberg, Macquarie FX Strategy, Nov 2019 Source: CBRT, Macquarie FX Strategy, Nov- 2019
Fig 48 Turkish Banking Sector CDS is at elevated levels
Fig 49 Core FX Reserves are below 3 months
Source: Bloomberg,, Macquarie FX Strategy, Nov-2019 Source: Bloomberg, IMF, Macquarie FX Strategy, Nov-2019
State Banks
Total Banking sector
85.00%
95.00%
105.00%
115.00%
125.00%
135.00%
145.00%
9 2
019
5 2
019
1 2
019
9 2
018
5 2
018
1 2
018
9 2
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5 2
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1 2
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5 2
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1 2
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5 2
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1 2
012
Loans to Deposit ratio
2250
2300
2350
2400
2450
2500
2550
2600
2650
Jul 18 Oct 18 Jan 19 Apr 19 Jul 19 Oct 19
Turkey Banks Balance Sheet Loans, TRY bn
Turkey
Indonesia
Argentina
5.00%
15.00%
25.00%
35.00%
45.00%
55.00%
65.00%
Ja
n 0
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Oct 10
FX Deposits as % of M2
0
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Nov 17Mar 18 Jul 18 Nov 18Mar 19 Jul 19
Effective interest rates are below the CBRT rateInterest Rate forConsumer Loans
Interest Rates forCommerical Loans
Interest Rate forHousing Lonas
CBRT 1 Wk RepoRate
Weighted AverageInterest Rate onTRY Deposits up to1Yr
0
100000
200000
300000
400000
500000
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800000
2/01/2017 2/01/2018 2/01/2019
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value with traded CDS
0
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4
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10000
20000
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90000FX Reserves vs Core FX Reserves
Turkey Gross FX Reserves Core FX Reserves
FX Reserves to Imports
Global FX Outlook: Peak USD
19 November 2019 29
ZAR: A will, but no way
The combination of low growth, structural barriers to economic reform, high and inexorable rising
debt, immediate credit rating risk and a relatively hawkish central banks means ZAR will be left out
of the EM rally in 2020. The immediacy of risks related to the sharp deterioration in the fiscal
position means investors will be unwilling to take the risk for the returns on offer. We forecast
USDZAR at 15.55 and 15.2 by end-2020 and end-2021, respectively.
Fiscal policy: teetering under the burden of SOEs and debt service costs
The South African National Treasury failed to find ways to offset increased funding for State
Owned Enterprises (SOEs) and reduced tax revenue due to weaker growth, resulting in a material
deterioration in the fiscal deficit and debt-to-GDP ratios in the Medium Term Budget Policy
Statement (MTBPS). A persistent primary budget deficit and no consolidation in the debt-to-GDP
ratio across the forecast horizon increases our conviction that Moody’s will remove South Africa’s
last remaining investment grade rating from Q1 2020. Following the MTBPS, Moody’s changed the
outlook on the sovereign’s credit rating to negative on 1 November and cut the country’s 2020
GDP forecast on 14 November. The Moody’s 1 November review implicitly sets the February 2020
Budget Review as the deadline to “halt and ultimately reserve the rise in debt” seen in the October
MTBPS or lose its last investment grade rating. Moody’s admitted that resistance to reform from
key stakeholders and a too big to fail problem at the state electricity provider means this may be an
impossible task. A Moody’s downgrade will immediately trigger South Africa’s removal from
Citigroup’s World Government Bond Index, leading to bond outflows of around USD15bn. We
remain relatively bearish ZAR.
• The MTBPS reported a material deterioration in the fiscus. The budget deficit is now
expected to peak at 6.5% of GDP in FY2020, compared to the February estimate of 4.5%.
• Debt-to-GDP breaks 70% to hit 71.3% at the end of the forecast horizon. The Treasury
failed to show a consolidating debt level, reinforcing the Finance Ministers own
pronunciation that debt is “unsustainable”
• Real GDP growth was downgraded across the entire horizon, with real growth failing to
reach 2% by the outer forecast years. The result was a ZAR251.2bn gross tax shortfall
over FY19 to FY22, resulting in a revenue shortfall of ZAR231bn over the period.
• Expenditure was revised higher throughout the projection period due to persistent bailouts
of SOEs and higher debt-service costs. Consolidated expenditure rose by ZAR55bn over
FY19 to FY22, driven by a ZAR88.5bn increase in payments to financial assets, how the
National Treasury classifies SOE bail-outs including Eskom. Debt-service costs were also
increased by ZAR27.4bn.
Monetary policy: a solution for the different problem
The National Treasury provided a figure of ZAR150bn in additional cost saving measures that
would be needed to achieve the fiscal target and stabilise government debt by 2020. Other than
saying the savings would come from containing the public sector wage bill, no tangible details were
given about how the government would implement something that has proven unachievable in the
past given the political capital of vested interest groups.
Fig 50 Both lower revenue and greater expenditure is
responsible for the downgrade
Fig 51 Change in FY19 tax revenue between Feb Budget and
Oct MTBPS, ZAR mn
Feb Budget Review Oct MTBPS
-8.00%
-7.00%
-6.00%
-5.00%
-4.00%
-3.00%
-2.00%
-1.00%
0.00%
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-2000
-1500
-1000
-500
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1000
1500
2000
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2019/20 2020/21 2021/22 2022/23
Revenue, ZAR bn
Expenditure, ZAR bnBudget Balance, % GDP
-60000 -40000 -20000 0
Specific exercise duties
Import VAT
Ad-valorem excise duties
Skills development levy
Customs duties
Other
Fuel levy
Domestic VAT
VAT refunds
Corporate income tax
Personal income tax
Gross tax
Global FX Outlook: Peak USD
19 November 2019 30
Source: South Africa National Treasury, Macquarie FX Strategy, Nov-19 Source: South Africa National Treasury, Macquarie FX Strategy, Nov-19
With inflation undershooting target and growth, especially domestic demand, subdued, rates
market pricing in 18bps of SARB rate cuts in the next 6month seems justified, even conservative.
However, the disappointing MTBR and Moody’s response in changing the rating’s outlook to
negative and cutting the growth forecast suggest the SARB will exercise caution. Credit rating risk
and thus the implicit risk to the ZAR and the inflation target will limit the SARB’s ability to act.
Furthermore, we believe the SARB recognises the limits of monetary policy to support growth.
Ultimately South Africa suffers from structural barriers to growth meaning monetary easing can
provide little help, only increase the risks.
Fig 52 Increased funding for SOEs is only partially offset by expenditure elsewhere, but expenditure growth has been revised down in key areas throughout the forecast horizon
Source: South Africa National Treasury, Macquarie FX Strategy, Nov2019
Fig 53 No consolidation in the debt-to-GDP ratio
Source: South Africa National Treasury, Macquarie FX Strategy, Nov-2019
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
0
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350
400
450
Change in consolidated government expenditure by function, ZAR bn
Feb Budget Review Oct MTBPS Average annual growth FY19-FY21 Average annual growth FY19-FY22
Feb Budget Review
Oct MTBPS
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
2019/20 2020/21 2021/22 2022/23
Gross public debt, % of GDP
Global FX Outlook: Peak USD
19 November 2019 31
Fig 54 Recent Foreign Net Inflows show complacency to
downgrade risk
Fig 55 Market expectations for SARB easing may be
disappointed
Source: Bloomberg, JSE, Macquarie FX Strategy, Nov-2019 Source: South Africa Nation, Macquarie FX Strategy, Nov-2019
Latin America: Will Politics Drive Performance in 2020?
Introduction and Summary Projections
Back in September, we were highlighting that the theme in Latin America was the slow-growth
trap that seemed to be ensnaring Brazil, Mexico, Chile, and Argentina. However, the consensus
that began to form in late Q3 was one that foresaw slow recoveries in 2020, at least for Brazil, Chile,
Argentina, and Mexico. (Colombia was an outlier that was already experiencing strong growth in H1
2019). The prospect of recovery, however slow, was based partly on easy monetary policy. Central
banks in Brazil, Mexico, and Chile were after all, easing in the wake of lower inflation. A global
recovery, predicated on a truce in the US-China trade war and on monetary policy easing
abroad, was also part of the more optimistic picture for 2020.
Of course, local politics and social conditions have are always figured prominently for
investors in Latin America, but the events of the past few weeks (in Mexico, Brazil, Argentina,
and especially Chile) have put politics and social issues front and center again. And these are
now seen as a significant factor potentially diminishing the relative importance of the global recovery,
local monetary policy, and the region’s own reform agenda as drivers of asset price performance
and regional FX returns in 2020. Indeed, traders now worry that politics and social unrest in the
region may upend both monetary policy and the reform agenda, deflating any recovery that
the region may otherwise have seen in a calmer political environment during 2020.
That’s why we keep the political and social trends in mind when we discuss the region’s
countries and their respective FX and rates outlooks, below. Are we worried about these
trends? It’s hard not to be worried. We’ve already seen how social and political revolutions have
already overturned the conventional views on Chile and Argentina this year, and both countries are
set to enter an extended period of uncertainty because of it. If Chile – the region’s safe economy –
can be hit, then Mexico, Brazil, and Colombia can be too.
-2000
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South Africa Net Sales to Foreigners, ZAR mn, 50 day rolling avg, normalised as of 2 Jan 2019
Fig 56 Macquarie’s FX and Policy Rate Projections for Latin America
Source: Bloomberg LP, Ministry of Economy
Argentina: Bondholders (and Growth) May Be Sacrificed in the Age of Protests Fernandez’ Frente de Todos Beat Macri’s Cambiemos. Argentina’s social and political revolution
came in October with the election of Alberto Fernandez, the candidate of the neo-Peronist Frente de
Todos coalition. He defeated President Mauricio Macri in a one-round election with 48.0% of the
votes (vs. 40.4% for Macri), thus ending the market-friendly tenure of Macri’s Juntos por el Cambio
administration. Of course, the Frente’s victory was widely expected since August’s primary election
(see here). Yet Macri’s Cambiemos coalition did OK in the Lower House (of Deputies) where it holds
46% of seats, and in the Senate (42%), hinting at an institutional balance among lawmakers. Still,
the composition of Congress won’t be very relevant for some issues in Argentina, such as how the
new government will be disposed toward external (i.e., foreign) bondholders. And yet the issue of
how bondholders are treated may determine when and if foreign capital returns to Argentina
eventually, and whether ancillary issues, such as the lifting of FX controls, takes place in the
foreseeable future. By extension, it also will determine whether growth resumes.
Fernandez May Reduce Debt Burden, But at a Cost to Bondholders. Although Argentina’s
current debt burden is high (see Figures, below), it can be made sustainable were fiscal spending to
be reduced, which would help maximize the value of its debt. But fiscal austerity would be
politically difficult for the new government to implement. And after all, even if debt sustainability
were not the issue, the new left-wing government would have a political incentive to avoid a large
fiscal adjustment, seeing as how fiscal adjustment (specifically, the removal of transportation
subsidies) led to a social explosion in Chile, next door. Fernández criticized Macri for slashing energy
and transportation subsidies. In four years, those federal subsidies went from 5% to 1.6% of the
GDP. So they could now go up again, under Fernandez, if the debt burden were to decline with a
restructuring that reduced coupon payments, haircut principal, or rescheduled maturities.
Fig 57 Argentina’s borrowing binge in 2016-18… Fig 58 …led to large debt service costs in 2019-2023
Source: Ministry of Economy, Argentina Source: Ministry of Economy, Argentina
Global FX Outlook: Peak USD
19 November 2019 33
The Region’s Social Protests Reduce Bondholder Power. Knowing that the new gov’t will have
a strong political incentive to reduce debt through a significant restructuring, and not adhere to fiscal
austerity, Argentina’s external bondholders have been organizing a “blocking minority”, in case the
new gov’t begins its negotiations by asking for a large haircut on Argentina external debt. The need
for blocking minority arises from the so-called “collective action clauses” – or CACs - in the bond
indentures. CACs require that if a super-majority of bondholders agrees to a debt restructuring, it
can impose the solution on all bondholders. As such, CACs are believed to reduce the power of
bondholders that reject a negotiated restructuring, since those holdouts are powerless to,
well, hold out, or bring their claims into Court.
Yet if a blocking minority can’t be put together, can bondholders avoid a large restructuring
if the government wants a large restructuring? To a degree, they can. After all, capital markets
would perceive an unnecessary squeeze of bondholders as a tactical default, setting in motion
processes that would be detrimental for Argentina’s future growth, its trade relationships, and even
its ability to service its restructured debt. The prospect of a long protracted fight in the courts
could temper the Argentina government’s demands, of course, but the new gov’t may not
care about issues such as trade and international integration that much if it risks street
protests of the kind seen in Chile if it relents to bondholders. After all, the political platform of
Fernandez and Cristina Kirchner has been to argue in opposition to the Mercosur-EU Treaty. They
have also argued in favor of a model of import substitution—which would make Argentina an even
more insular economy.
Moreover, the IMF (which is now a major creditor to Argentina) is likely to want Argentina’s external
debt to be sustainable and serviceable, so that the IMF’s exposure is minimized, before resuming
disbursements. It may also adopt a sympathetic view toward the government, in view of the risk of
social unrest. As such, external bond-holders may see their interests in conflict with the
government and the IMF, putting them at a disadvantage in negotiations.
How Long Must We Wait to See What Happens? Our analysis of how much FX Argentina could
muster through the use of its net international reserves and any prospective current account surplus,
suggests that it may have between USD 10bn and USD 15bn of “play” left to deal with debt service
costs, assuming that no new foreign capital is sourced. On the basis of this, and the amount of debt
service payments over the next year, we believe that negotiations with bondholders may last for a
year before Argentina is apt to begin defaulting on principal and coupon payments to external
bondholders. That relatively ‘short runway’ works to the negotiating advantage of the government,
rather than the creditor. Once reserves run out, bondholders may wish to ‘deal’ so as to avoid the
prospect that coupons are missed and that their bonds become ‘zombie’ bonds.
Fig 59 Not all Reserves can Be Used to Pay Debtors… Fig 60 Net reserves are likely no greater than USD 10bn
Source: BCRA, Argentina Source: BCRA, Argentina
Might Fernandez Treat Bondholders Well? There has been some ‘hope’ that Fernandez would
adopt a more conventional view of bondholder rights, but there is little tangible support for
this yet. Fernandez recently said that the 2003 Uruguayan debt restructuring might be a better path
Global FX Outlook: Peak USD
19 November 2019 34
for Argentina to follow. In that restructuring, there was voluntary debt exchange that lengthened
maturities by 5 years while keeping coupons and principal constant. The process was widely viewed
as “friendly” as it was completed with 93% participation, and because Uruguay was able to access
international credit markets within the year. But there is no way of really knowing if this comment
was intended to keep markets calm until the election. Moreover, the Uruguayan restructuring
involved not just a haircut, but also required a significant fiscal adjustment and important structural
reforms - which would go against Fernandez’ promises on the campaign trail. So, when Fernandez
is confronted with the need to avoid a fiscal adjustment and reforms, he may abandon the Uruguay
plan. The other unknown factor is the role that Cristina Fernandez Kirchner will play as Vice-
President. She may stay on the sidelines at first, as Pres. Fernandez negotiates with
bondholders and the IMF, but she may exert her influence behind the scenes, and her
disposition is likely to be antagonistic to the bondholders.
Bottom Line: Watch How Bondholders Will Be Treated. If there is to be a signal of whether
the new government will be “market-friendly”, it will come in the way that the new gov’t treats
bondholders in the negotiations over the next year. A willingness to reschedule the maturity of
Argentina’s external bonds (instead of large haircuts) would be such a signal, and traders would use
this to anticipate other “market-friendly” actions, including a commitment to fiscal austerity. But so
far, the government has not suggested that it would adopt fiscal austerity or treat bondholders with
largesse. As such, we remain skeptical regarding outcomes in Argentina over the next year.
We believe that FX controls, for example, will persist throughout 2020, ensuring that capital flight is
minimized, but not prevented. At the same time, we remain concerned that the BCRA’s monetary
policy to date – of fixing the monetary base – will be abandoned in favor of monetary finance of the
deficit. The bias in this backdrop, of course, is toward a cheaper ARS over time.
Brazil: Success with Reform, But Politics Becoming Less Benign
Unlike Argentina, Brazil has Seen Favorable Politics. That positive backdrop facilitated the final
passage of pension reform in the Congress in October, which was a major benefit in stabilizing
Brazil’s gross debt-to-GDP ratio over the coming years. More importantly, the passage of pension
reform demonstrated to the skeptics that there was an alignment in Congress for the government’s
reform agenda more broadly. It also demonstrated the political skill of the economy Minister, Paulo
Guedes, during a period in which President Bolsonaro largely stayed out of the debate in Congress.
But Politics Hasn’t Made Us Bullish on the BRL in the Short Term. Yet despite the recent good
news on reform, we’ve noted that there are a few forces that are still militating in favor of a weaker
BRL, and our year-end 2019 projection is 4.25 for the USD/BRL, before we see some stabilization
in the pair in 2020, on the premise of reform.
First, we remain convinced that the BRL remains under competitive pressure from the recent
devaluation of the ARS. Brazil, after all, conducts about 20% of its gross trade with Argentina, its
3rd largest trading partner after China and the US. Conversely, Brazil is Argentina’s largest trading
partner, followed by the EU and China. The recent depreciation of the CLP, while not as impactful
for Brazil’s competitiveness as the ARS, may also impart some competitive pressure.
Fig 61 Brazil’s trade balance suffered in the Argentina devaluation of summer 2018
Fig 62 …with the slowdown in trade weighing on both industrial production and GDP
Brazil’s trade balance with Argentina, Dec. 2013 to Mar. 2019, in million USD
Argentina’s and Brazil’s auto exports, by destination (2017, in billion USD)
Global FX Outlook: Peak USD
19 November 2019 35
Source: IMF data, via Bloomberg LP Source: Trade Map
Second, and at least for the time being, the central bank’s (BCB’s) decision-makers are
implicitly pursuing a weak-BRL policy, with an aggressive pace of policy-rate cuts that will
likely endure into December with another 50bp reduction in the SELIC target, before the target
eventually settles at 4.00% with another two 25bp cuts.
The Copom’s recent statement highlighted how underlying inflation measures are “running at
comfortable levels”, and that the “the consolidation of the benign scenario for prospective inflation
should permit an additional adjustment of the same magnitude” – i.e., -50bps in December – even
though “the current stage of the business cycle warrants caution when considering “possible new
changes in the degree of stimulus”. The assessment of the current situation saw Brazil’s economy
improving only gradually. Projections of CPI inflation for 2019 and were kept unchanged from
September at 3.4%, 3.6%, respectively, but the 2021 projection of 3.5% remained well below the
respective mid-points of the inflation target ranges for that year (3.75%). That suggests that if the
Copom were trying to achieve inflation convergence over a multi-year period, rather than
inflation stability, there is room for more cuts in the short term to reduce the base from which
interest rates may have to rise later. We also note that long-term inflation breakevens remain
historically low, at around 3.85%, and comfortably within the BCB’s +/- 2% range around the 3.5%
2022 midpoint. The Copom, in effect, is OK with a weaker BRL.
In 2020, Though, Things Get Interesting. Following the current bout of weakness, however, we
see a better environment for the BRL in 2020, and expect relative steadiness, compared to the
upward trend in USD/BRL of 2019. The BCB’s rate cuts after all, will end by Q1 2010, allowing
investors to focus on the pending recovery in Brazil. That recovery has already started it seems, with
the recent uptick in consumption, although it is yet to reveal itself in better industrial output, owing to
ongoing competitive pressures. But more importantly, it is Brazil’s structural transformation
that may move into the limelight in 2020.
For our part, we have been cautiously optimistic about the passage of new reforms in 2020,
or at least more political progress toward reform. This includes a tax reform, central bank reform,
a new bankruptcy law, administrative reform, and new laws governing public-private partnerships to
help enable asset sales. Asset sales themselves (i.e., further sales of public-sector companies,
mineral concessions, and infrastructure facilities, such as ports) are likely to also be prominent in
2020. Why stay optimistic? Admittedly, recent events in privatization have not gone well, after all.
Brazil’s auction of deep-water profit-sharing agreements didn’t see significant interest from foreign
oil companies in November, but we would attribute that to a poorly-designed auction mechanism,
rather than poor politics. Instead, we’d rather look at political support for Economy Minister Guedes’
economic policy agenda. On that count, public support remains above 50%, even though
approval of Bolsonaro himself barely rests above 30%.
Are There Political Risks? Of Course. Indeed, in the very past few sessions, some events have
cast doubt on whether politics will stay conducive to Brazilian reform in 2020. The biggest of these
events was the release from prison of former President Inacio Lula da Silva. His release was the
result of a generic case before the Supreme Court, in which it decided that convicts could stay out
of jail while they have yet to exhaust the court system’s appellate process. The bad news is that this
means that Lula will return to the political spotlight and take an active role in his Workers’ Party,
although he is barred for now from running for political office. But there is some ‘good news’ in this
too, perhaps. First, Bolsonaro’s popularity is based on his image as the "anti-Lula," so he will use
this to rally his own support base, and possibly fight harder for reform. The return of Lula may also
hamper the emergence of new leaders at the PT, who could otherwise had more vigor to challenge
the administration’s agenda. So this may reignite some left-right polarization in Brazil, but it
may also cause Bolsonaro to pursue reform more aggressively by “getting in the game”. We
would get more concerned, however, if the Supreme Court would annul Lula’s conviction completely,
as this would return his eligibility to run for the presidency in 2022.
So we remain cautiously optimistic about momentum in the reform process, but just as
Argentina, Chile, and Mexico have not been immune to a return of left-wing political and
policy agendas, of late, Brazil’s political outlook is important and requires monitoring.
Chile: Social Unrest Culminates With the Uncertainty of a Constitutional Change Before the Riots Began, We Weren’t Fans of the CLP. That’s because we saw Chile’s economy
as prone to being buffeted by global trends largely outside of policymakers’ control. That made for
Global FX Outlook: Peak USD
19 November 2019 36
higher risks, and traders need higher expected return to assume higher risk – i.e., a cheaper CLP.
Moreover, we saw little incentive for the BCCh to fight against any CLP weakness. The BCCh was
structurally dovish we argued, expecting that Chile’s disinflation process would endure for many
quarters, if not years. Finally, we couldn’t count on structural reform, either. Expectations for reform
in Chile were high when the center-right government of Chile Vamos, led by President Sebastian
Pinera, took over. But the lack of a legislative majority for his coalition and allies (due to
institutional changes in the way seats are allocated in the Congress) had kept the reform
initiatives on the back foot. Among the most important reforms that have stalled include a
modernization of the tax, healthcare, labor, and pension systems. And as these reforms have stalled,
the far left in Congress has become more assertive, pushing for anti-market measures such as
minimum wage legislation. The inability to pass reform, against a backdrop of low growth, had
led to lower support for the government, with Pinera around 30% in approval ratings.
So there was already tinder in place when Chile’s street riots began in mid-October. Although
ostensibly set off by an increase in public transportation fares, political polarization and
disaffection were already high.
Riots Set Off a Process of Reform Reversal. What happened in response to the riots, however,
is what mattered more for traders and investors. First, Pinera’s government remained unwilling to
make concessions to the street movement. Then, the opposition took advantage of the situation.
Seeing as the riots had unearthed the disenchantment of the middle class, and pointed to a rejection
of market-oriented reforms that Pinera’s gov’t was still trying to get passed at the time that the riots
broke out, the opposition pressed for a reversal of reforms. The government conceded by broadening
some social entitlement programs (health insurance, pensions), and allowing an increase in
minimum wages. Yet in a late October poll, 80% of respondents said that those “reforms” were
“inadequate, and social protest spread to other segments of civil society – unions, students, etc.
The Dam Broke When the Government Proposed to Revamp the Constitution. With the riots
expanding to encompass protests by other segments of society (e.g., unions), Pinera’s gov’t threw
in the towel on the weekend of November 9-10, by offering to initiate a process that will revamp
Chile’s Constitution. Notwithstanding that the current Constitution has already been seen major
amendments introduced several times since it came into force in 1990, traders now feared that a
wholly new Constitution will codify various entitlement programs as “inalienable rights”. That would
make the new Constitution more rigid, and potentially “lock in” an extended period of higher fiscal
spending, and effectively attenuate Chile’s reputation as a market-friendly country with stable
institutions. (This, despite the government’s stated purpose of writing a new Constitution to expand
“civil participation” in the democratic process.) It’s no wonder, then, that the USD/CLP rose to 800
in the trading that took place after that announcement, before the BCCh stepped in with a
program to provide USD liquidity through short-term swaps, auctioned over a period of
several months.
Next Comes a Long Period of Uncertainty. In our view, the prospect that Chile will undertake to
draft a new Constitution risks stacking the political environment against the pro-market political
forces, given that these forces were already flailing before the riots began. Indeed, a recent poll
shows that 52% of respondents prefers a whole new Constitution, while only 42% favor new
amendments only. Pinera’s polls are too low to resist the thrust, with his approval rating now close
to 14% - a historic low in Chile. And of the 52% that want a new or amended Constitution, roughly
2/3rds say it is necessary because a “new agreement with citizens” to meet “new times” is needed.
The balance say it is needed because it “originated in the dictatorship”. (The Constitution of 1988
emerged out of a series of pro-democracy organic laws that were instituted by the dictatorship of
Augustin Pinochet.) And on the matter of the protests, 72% agree that they should go on, suggesting
that social unrest will now become a way for segments of civil society (unions, students, etc.) to
ensure that their agendas are reflected in the new Constitution. The principle risk is that drafting
a Constitution will be fraught with social unrest, while traders see the uncertainty associated
with the process as an excuse to shun the local market.
GDP to Worsen in Q4, But BCCh May Not Cut in December. Even though Chile’s Q3 growth was
solid at 0.7% quarter-over-quarter (3.3% year-over-year), there’s now little doubt in our minds that
Chile will suffer a significant decline in Q4 GDP growth that approaches a recession. There’s also
no doubt that the BCCh is structurally ‘dovish’, given it’s a priori belief that Chilean inflation was
being subjected to structural changes that would keep inflation low. However, even a dovish
central bank has its limiting principles, and we doubt that the BCCh would be quick to cut the
policy rate again in December. Indeed, the policy Minutes (for the Oct. 23 meeting) released on
Global FX Outlook: Peak USD
19 November 2019 37
Monday (the 11th) had already brought no confirmation in the forward guidance to suggest that a cut
was coming. The policy Board made the case that recent events would have an impact on
inflation that is uncertain and “not obvious”. Yet since those Minutes were prepared, the impact
has become more obvious; the major depreciation in the CLP almost ensures that pass-through will
be reflected in higher inflation on a six-month horizon. And this is in addition to the negative supply
shocks emanating by the various logistic disruptions since the protests began. So we conclude that
the BCCh is even more likely to refrain from easing in December, and to keep the policy rate
(the TPM) at 1.75%.
Fig 63 With the recent depreciation, Chile’s CLP reached its historical lows on a real effective exchange rate basis
Fig 64 With pass-through, inflation is set to go higher
Source: JP Morgan, via Bloomberg LP Source: Bloomberg, Macquarie calculations
What Happens to the CLP? We argued on November 12 (here) that traders that went short CLP
vs. the USD or vs. other crosses, such as the COP, should consider taking profit tactically when
USD/CLP had reached 800. After all, the two-day spike in USD/CLP to 800 after the weekend of
Nov. 9-10 was a three standard-deviation event. And as far as economic benchmarks go, the CLP’s
real effective exchange rate (CPI based) had declined to a point where the CLP is as cheap as it
was in 2003, 2008, and late 2015, but not cheaper than at those points. However, because of the
issues noted above, this is unlikely to be the week of Nov. 10-16 is unlikely to mark the end
of the general political turmoil in Chile. So we expect that after the USD/CLP settles below
800 for a brief period, long-term hedgers will come out. The prospect of a political-economic shift
(coming with a new Constitution) may eventually work to ensure that the real value of the CLP is
undergoing a structural revaluation, making the range-benchmark levels for the CLP and its CPI-
based REER obsolete. We see these pressures acting on the CLP throughout this period of
uncertainty, with USD/CLP eventually climbing again, toward 840 by end-2020.
Colombia: The Region’s Growth Leader – But Don’t Discount Prospect of Unrest Growth Outpacing the Region’s. On reason we’ve liked the COP is that we have felt that its value
would reflect Colombia’s standing as Latin America’s growth leader. Indeed, recent growth in
Colombia has been coming in at multiples of the growth at its Latin America peers, where until Q3
ended growth slumps still prevailed. The growth data in Colombia has also stayed loftier than
we or most analysts expected in recent months, suggesting a still-strong turnout for H2 2019.
For example, the monthly estimate of GDP (the ISE) showed that activity is still picking up speed in
Colombia, with a 3.7% year-over-year gain compared to a 3.6% increase in Q2. This continuing
strength reinforces the view that overall growth won’t soften just yet in Q3 2019, and the carryover
(of strong H2 growth) may still produce growth of roughly 3.5% in 2020 (all else equal), keeping
Colombia a growth stand-out on a year-over-year basis, in 2020.
Why Has Growth Been Stronger Than Peers? One reason is the government’s ongoing
infrastructure expansion, especially in 4G telecom infrastructure. But Colombia policymakers like to
attribute the growth to the government’s pro-growth reform policies. In the “official view”, the fiscal
reform 2018, which reduced the corporate tax rate from 37% to 33%, and enacted other incentives
Global FX Outlook: Peak USD
19 November 2019 38
to investment – such as a reduction in the VAT for capital goods imports – caused the surge in
investment, which multiplier effects carried consumption along. The “official view” has some
merit, as recent growth is driven by investment, rather than consumption. For the first time in
many years, in fact, growth in Colombia’s gross fixed investment has exceeded growth in household
consumption, although both have recently run just above 4% per annum – i.e., both strong.
…And the Regional Inflation Leader. Colombia’s strength, however, has come at the “cost” of
some inflation, with CPI now tracking near 3.8% year-over-year. Indeed, following a September print
that saw CPI inflation accelerate, inflation is now tracking near 3.8% year-over-year, alongside a
0.22% month-over-month increase in the CPI. September’s inflation reflected sturdy food price
increases of 0.48% month-over-month, after a 0.13% drop in August, and energy prices increased
by 0.46% month-over-month from a previous -0.09% change. On annual terms, food prices now
account for about 25% of annual inflation, and core inflation continues to diverge further from
BanRep’s target, at 3.4% year-over-year. In effect, the anticipated decline in Colombia inflation
has not yet occurred. Naturally, because we are speaking of consumer prices, strong
household demand is partly to blame. Data released last week showed that retail sales jumped
9.5% year-over-rate in August, up from 8.1% in July, and the underlying trend is rising. Core retail
sales, excl. fuel and autos, rose 11.2% in August, accelerating from 8.4% in July and 7.2% in Q2.
…But BanRep is Unlikely to Hike in Q4 2019. Colombia’s BanRep hasn’t yet responded to this
inflation, with its most recent rate action being a cut in its repo rate to 4.25%, back in 2018. But
Colombia’s BanRep remains among the more ‘hawkish’ central banks in the region. And for good
reasons – the anticipated decline in Colombia inflation has not yet occurred. Moreover, the ongoing
boost from a hefty infrastructure program, including at the local level as municipal elections approach
in Q4, are supporting an activity upturn. Data last week showed that retail sales jumped 6.9% year-
overrate in September. With that, why didn’t the BanRep just hike rates at its October 31
meeting, and why won’t it hike on December 21? It could, of course, do so. But it is likely
restrained, for now, by a few factors:
(1) First, there’s the fact that inflation expectations for 12 and 24-months ahead remain relatively
well-anchored at 3.4% and 3.2% year-over-year, still suggesting no divergence from target.
(2) Second, as noted above, the spike in September inflation derived mainly in the non-core areas,
especially food, owing to supply-shocks related to the weather. That’s expected to be a
transitory factor, according to our recent meetings with BanRep officials. Core inflation is lower,
and BanRep has expressed to us that it is confident that core inflation is in structural decline.
(3) Of course, the inflation seen may reflect pass-through from the weaker COP in July and August,
but with global conditions possibly set to improve if there is a ‘truce’ in the trade war, BanRep
may conclude that pass-through will have limited impact on inflation. The BanRep generally
perceives that pass-through is low, in any case, at no more than a 12% ‘delta’. In any case, it
was worry about pass-through that led to speculation in early October that the BanRep would
intervene in the FX market. BanRep didn’t intervene, however, bolstering the case that it
sees the inflation burst as not something that should warrant higher interest rates for the
purpose of stabilizing the COP.
(4) Fourth, there is uncertainty about whether Colombia’s tax reforms will remain in effect,
after they failed to withstand judicial review a few weeks ago. The Constitutional Court has
recently struck down the tax breaks passed in 2018, on the premise that its passage in 2018
had procedural irregularities. This uncertainty will stay BanRep’s hand, throughout Q4.
Ultimately, however, we believe that the congress will pass the fiscal reform measures
again, by end-2019, averting a fiscal contraction.
So we don’t yet see a rate hike in Q4 2019. But we also believe that BanRep is unlikely to hike
in H1 2020 either. That’s because we expect that growth will slow at the margin in Colombia
as we enter 2020, even though that is not the intention of the government.
One reason is that the government’s aggressively hawkish fiscal targets would leave at least
some of the burden for stimulus on the BanRep in 2020. The 2020 Budget would lock in the
more fiscally responsible spending contours in 2020 (see Figure, below). (The draft 2020 budget
curtails public investment by roughly 0.3% of GDP. In the absence of an oil-price recovery, the deficit
Global FX Outlook: Peak USD
19 November 2019 39
targets are likely to remain highly pro-cyclical, even as they help Colombia avert a rating downgrade
as the rating agencies wait to see how the debt-to-GDP ratio evolves.)
Another factor that would be a further slowing in areas where there’s already been some weakness
- i.e., residential and commercial construction (which makes up 40% of gross investment). Housing
prices in Colombia’s main cities have remained solid for several quarters, and haven’t seen a
reversal through Q2. But builders are likely sensing an oversupply following the building boom and
high prices of the 2012-2016 period, and are curtailing construction activity. In addition, consumers’
expectations for their future economic situation, have deteriorated consistently since April,
suggesting that consumption may slow further, putting an even greater onus on investment. Thus,
Q2-Q3 growth may be a ‘peak’, and the economy will come under pressure by Q1 2020.
We think that BanRep will be forward-looking in its assessment of growth, seeing growth slowing in
sequential terms in 2020, but the optics of a strong year-over-year growth may matter enough to get
the BanRep to also avoid easing ‘prematurely’ in H1 2020. So we see a standstill in policy rates
in H1 2020. We’re still more inclined, however, to believe that the ‘next move’ is a cut, although that
comes way ahead in H2 2020, by which time inflation will have receded, and Colombia can ‘catch
up’ with the low policy rates that will sill prevail in the region.
Colombia’s External Risks are not as Bad as They Seem. It is legitimate to ask why the COP
hasn’t done better under a still vigilant BanRep in 2019 and despite strong growth. In our view, that’s
because traders continue to attach several downside risks to Colombia and the COP, although some
of these risks aren’t as scary as they seem to be. What are these risks and why are they not as
scary as they seem?
1. One ‘risk’ is that oil seems to be in structural surplus, with prices declining. Oil prices
are still relevant for the terms of trade, but less so for the budget and for FDI. That’s because
efficiency gains have resulted in extraction breakevens moving from USD 65/bbl. Several
years ago to USD 45/bbl on a Brent-equivalent basis. So activity in the sector is far from
slowing down. Moreover, oil production itself is growing at 4% p.a., - giving the government
revenue support even if prices edge lower. Our recent meetings with Finance Ministry
officials also revealed that Colombia will begin to hedge the oil exposure in the
Budget, the way that Mexico does.
2. The second ‘risk’ is Colombia’s large current account deficit, about 4.25% of GDP is
wide, creating a challenge for the COP. Yet traders also forget that Colombia’s strong
FDI inflows, about 4.75% of GDP— particularly to activities related to the oil sector—
persists, despite weaker oil prices. That is, FDI inflows remain above what is needed to
finance Colombia’s current account deficit, and with FDI growth of 24% in 2019,
coverage of the CA deficit is likely to continue into 2020.
3. Also, traders forget that nearly 3/4 of Colombia’s current account deficit derives from
up-streamed dividends payments made to foreign owners of Colombia’s companies.
This is the result of many years of international investment in Colombia’s oil sector and
other sectors. (Only 1/4 of the CA deficit actually arises from a net trade deficit and net
transfer payments.) In times of stress or declines in corporate revenue, those
dividends would be adjusted lower, curtailing USD demand. Finally, remittances are
now 2% of GDP – a hefty sum that is starting to rival Mexico (at 3%).
Global FX Outlook: Peak USD
19 November 2019 40
Fig 65 As a % of GDP, Colombia’s deficit is set to fall Fig 66 The large CA deficit isn’t from a high trade deficit
Source: Ministry of Finance, Colombia Source: Bloomberg, Ministry of Finance Colombia
4. Another ‘risk’ to the COP in early 2019 had been the BanRep’s own reserve
accumulation policy, through regular FX intervention. But reserve accumulation was
suspended in mid-2019, as BanRep reassessed its own reserve adequacy levels. Largely
because of FX purchases, Colombia’s int’l reserves have jumped by USD 3bn in the past
two years, going from USD 48bn to USD 52bn, currently. This has left Colombia with an
enhanced level of reserve adequacy as of Q4 2019, with reserve coverage at 1.4x the level
the IMF believes represents adequacy. Of course, this doesn’t ensure that reserve
accumulation won’t restart. But it does suggest that if BanRep begins to buy USD
again, the pace may be slower and less disruptive for the COP. Mitigating the need to
engage in FX intervention is also Colombia’s flexible credit line (for USD 11.4bn) with the
IMF (Colombia is one of only two EMs with an active FCL, the other being Mexico).
5. Finally, the last ‘external’ risk is the risk of a rating action taken by the rating
agencies. However, conversations we’ve had with S&P recently revealed that the agency
sees Colombia’s fiscal adjustment as being underway, and is therefore unlikely to
downgrade the credit. Indeed, we are less worried about a downgrade of Colombia than
we are of Mexico’s for example. The promise that Colombia will undertake its promised
strategic disinvestments of state assets by late 2020 or in 2021 will also keep the rating
agencies at bay, at least through 2020, in our opinion.
Fig 67 Colombia’s reserve adequacy is solid Fig 68 Colombia has been the region’s safest economy
Source: IMF. The ARA is the IMF’s estimate of the optimal level of int’l reserves, based on minimizing external vulnerability, relative to the opportunity cost of reserve accumulation.
Source: Bloomberg, Macquarie calculations
Number of Years from 1980 to 2018 with
Negative GDP Growth
Global FX Outlook: Peak USD
19 November 2019 41
The COP Offers a Better Reward-to-Risk Ratio. After all, despite the exposure to oil prices and
the perceived external vulnerabilities, Colombia’s GDP has been remarkably stable over four
decades, with the economy suffering only one negative-growth year since 1980. From that
perspective, it is safer than any of the major Latin American economies or currencies. Moreover,
given that one of the extant risks in the world is a disruption in oil supplies, the COP at least offers
an interesting diversification within local currency portfolios. That combination of the high relative
carry, relative safety in the growth variance, combined with diversification benefits will keep the COP
relatively steady in 2020, in the context of a USD that will be weakening against the major currencies
(EUR, AUD, and GBP). We project stability around 3400 in Q4 2019 to Q1 2020, followed by
slow depreciation to 3600 in keeping with an eventual return to more ‘dovishness’ at BanRep,
alongside a growth slowdown by H2 2020.
Why Stability and Not Gains for the COP? Because the country’s political travails are unlikely
to get investors to take a huge leap into Colombia’s money markets, despite strong growth.
The euphoria over the installation of Ivan Duque as President in 2018 has clearly faded, as Duque
made missteps in the peace process, and in urging for too-aggressive a tax reform in 2018-2019 –
one that was eventually watered down. Also, with the protests in Chile, anxiety has been building
over labor-strike activity in the short term and into 2020, and the left-wing opposition is likely to take
advantage of Duque’s declining ability to govern to protest periodically. Other domestic risks are a
return to arms by former commanders of the Revolutionary Armed Forces of Colombia (FARC)
heightens risk that demobilized guerrillas will abandoning the peace and target both urban and rural
areas. Of course, President Ivan Duque – partly because of dissatisfaction with how he has managed
the fragile peace – remains unpopular. So the COP will be prone to periodic volatility over protests
and demonstration sin late 2019 and 2020. But because Colombia is no stranger to internal
conflicts, the authorities should be able to deal with social unrest much faster than their
counterparts in Chile.
Mexico: Some Risks Mount as Year-End Approaches
As an Economy, Mexico Disappoints. Our beef with Mexico was that in the absence of market-
friendly reforms that liberalized the economy’s various sclerotic sectors, especially the oil sector, it
would be difficult to generate growth. And yes, industry has been still sluggish in Q3, with output flat
in September. And we are acutely aware that Q4 could be worse for Mexican industry since GM’s
strike contributed to a 16% plunge in auto production (year-over-year) in October, including a 30%
drop at GM’s local factories. Looking ahead, with the prospect of some softening of the
consumer in the US, with “peak car”, and with the USMCA to place competitive disadvantages
on Mexico, the outlook for the auto sector - and hence IP - is not good. After all, industry and
the auto sector are closely linked in Mexico, given the county’s integration with the North
American supply chain. And with growth compromised, concern that revenue generation at the
federal level will be impaired will be a lingering concern, especially as oil-related revenues, too,
continue to suffer.
In this context, there’s really been only one solution to Mexico’s “slow-growth trap” – a
supply-side solution that allows for free-market price determination, and liberal entry and
participation of the private-sector into the heretofore state-controlled sectors – starting with
energy, and extending to energy distribution, electricity, etc. Indeed, allowing private-sector
participation would attract foreign participation, allowing Mexico to finance its external deficit with
more FDI, rather than relying on the money markets. It would also absolve Mexico’s federal
government of the need to ‘bail out” key parastatal companies – first on the list being Pemex, which
will require a government assistance plan in 2020. If this ‘road not taken’ were taken, the MXN
would have appreciated, allowing Banxico to ease policy earlier, and still have the benefit of
lower inflation.
But rather than that, the policies of President Andres Manuel Lopez Obrador have had a deleterious
effect on growth. The attempt to curtail government spending in the face of falling revenue, for
example, has resulted in cuts in the government’s administrative functions and personnel. This
hollowing out of government has potentially amplified the already pro-cyclical effects of public-sector
compensation cuts. So although traders and investors could applaud AMLO for maintaining a
narrow budget deficit in the face of lower revenue growth, the way fiscal savings has been
generated has been counter-productive. Moreover, the threat of higher taxes to fill prospective
Global FX Outlook: Peak USD
19 November 2019 42
budget holes has hung over the private sector, in any case, largely as AMLO refused to cut spending
in social programs.
Until Now However, Mexico Hasn’t Faced a Crisis That Would Make it Change Tack. Sure, slow
growth and the threat of rating agency action has promoted a few small changes to policy (such as
the accommodation recently made to the private sector in Mexico’s contentious natural gas
distribution sector, and an effective response to the problem of migration into the US). And AMLO
has been forced to disassociate himself from his own party – MORENA when it has become even
more radicalized toward the Left than he wants to be. But AMLO has yet to make a philosophical
turn, leaving it up to his cabinet ministers to offer incentives to the business sector to ramp up activity.
(The latest was the Finance Ministry’s announcement of a forthcoming group of investment
initiatives, to be presented on Nov. 26th.) But hints that the broader policy thrust is changing
has not yet come from the administration, as AMLO continues to blame the neo-liberal model
of the past 36 years, for Mexico’s current problems. In effect, that means that Pemex will remain
a burden on the fiscal outlook, prompting rating agency review; foreign investment will be deterred
from participating in key sectors; and efficient governmental administration will continue to
disappear.
The End of 2016 May Present Traders with “Pressure Points”. For one, Mexico must still pass a
2020 Budget (by November 15, in the Lower House) that adheres to the promise of a small primary
surplus. The proposed Budget (released on Sept. 8-9) has already brought scrutiny from traders
because of less-than-realistic assumptions about revenue growth (especially oil-related revenue
growth), about the assistance that Pemex will receive, and the 2020 GDP growth assumption of 2%.
Moreover, the Budget assumes an increase in oil production of 15% over 2019 (the projection is
1.95mn bbl per day), which remains ambitious over the 1.7mn bbl run-rate. Further, the Budget
makes its 0.7% primary surplus target by further squeezing administrative costs, rather than social
spending. (The consolidated deficit is -2.1% of GDP.) Upon further examination, there may be also
some ‘fudges’ uncovered, such as measures to re-label tax increases as loophole closures. We
don’t know if the Budget and the assumptions in it will in will invite more scrutiny by the
rating agencies, but we suspect it will.
Fig 69 Mexico’s industry depends on its auto sector Fig 70 Mexico L-T Inflation breakevens are still too high
Source: Bloomberg LP Source: Bloomberg LP
Banxico’s Board Is the Sole Conservative Policy Bastion. In the absence of growth, what is
holding up a faster reduction in Mexico’s policy rate? For one thing, Banxico’s policy Board
remains “conservative” in its overall composition, seeing the risks from easing too quickly through
the lens of eroding central bank credibility. Inflation, after all, had stayed high for two years,
following the depreciation in the MXN associated with the US presidential election in 2016.
Moreover, Banxico has been, since 2019, concerned with the implication that the current
administration’s policies would impart adverse (negative) supply shocks, resulting in more capacity
constraints on the economy, and hence higher inflation. There has been little trust by Banxico that
fiscal policy would be in the ‘responsible range’ either. Hence, Banxico didn’t start its easing cycle
until August 2019, and has only cut rates three times since (by 75 bps overall) starting from a level
Global FX Outlook: Peak USD
19 November 2019 43
(8.25%) that was quite high in both nominal and real terms when compared to other EMs. To be
sure, Banxico’s Statement in November alluded to the risk that core inflation was not declining
quickly enough, but also to the supply-side problems: (1) of a lack of “certainty” for the investment
decisions, (2) of wage growth that exceeds productivity growth, and (3) of achieving fiscal targets.
Largely because of the persistence of these problems, it did not cut the policy rate faster – i.e., by
50bps.
Also, what isn’t working in favor of easing are inflation expectations. Yes, breakevens have
retreated in recent months, as have survey-based inflation projections, but both long-term and
short-term inflation projections remain well above the 3% target of the central bank.
…While Social Issues Pose Risks to the MXN Too. Mexico has not been immune to social
unrest in the past few weeks, and the stability associated with AMLO’s first year seems to
be at risk because of the recent events that have brought violence to the limelight again.
AMLO said that he “laments” cases such as the recent assassination of US citizens, but also that
his gov’t will “continue to act in the same manner” – i.e., not change its public-safety strategy.
AMLO seemed fairly certain that those policies were “doing very well” and that the country will
gradually “overcome all that which was inherited from failed policy” – including violence. AMLO’s
remarks may refer to his policies having disbanded drug cartels, but the violence is now being
conducted increasingly by scattered gangs, many of which rely on threatening or extorting locals
rather than working in drug trafficking. So foreign direct investors may not be so forgiving, nor
will tourists.
We’ll note that foreign direct investment has already deteriorated since AMLO became
president, and we believe that it is set to deteriorate further in view of an apparent
unwillingness to address violence more directly. Indeed, we think that some of the MXN’s
recent weakness is linked to the negative headlines.
MXN Won’t Fare Well, and Banxico Will Forced Into Conservative Path for Rates. The
Bottom Line is that a combination of supply-side constraints in Mexico, combined with still-
high inflation and a Fed that is no longer in easing mode will keep Banxico among the central
banks that are not succumbing to pressure to ease aggressively. Beyond 2019, we see the rate
easing cycle extending, but slowly. Uncertainty regarding AMLO’s agenda will also persist,
especially under the lasting threat that the MORENA party’s radicals will gain more legislative
power. And finally, while passage of USMCA is good (vs. not passing it), the demands that the
Democrats will make on Mexico’s environmental and labor standards will also erode productivity.
That augurs a still-weak MXN and an inflationary impulse. And it also means that after
reaching 19.50 at year-end, we foresee USD/MXN rising further, to 20.75 by year-end 2020,
making the prospect of taking the risk of earning the carry less compelling.
Global FX Outlook: Peak USD
19 November 2019 44
Detailed FX Forecasts Table
Fig 71 FX forecasts (end of period, forecasts shaded)