Sound Money Sounds Good


Decisive monetary policy has brought inflation under control in Mexico and Brazil,helping to lift the value of their currencies and support growth

Decisive monetary policy has brought inflation under control in Mexico and Brazil, helping to lift the value of their currencies and support growth 

One of our observations about the history of emerging markets is that more domestically-focused emerging economies have a tendency to see synchronous upswings (and downswings) in economic growth, equity markets and currencies. In more export-led markets, weaker currencies boost competitiveness and growth, but those countries that tend to run current account deficits have net external financing requirements, so the capital inflows that support currencies also drive economic growth.

Two markets that have historically displayed this pattern are Mexico and Brazil. Despite some more challenging conditions for emerging markets in general, both have seen strengthening currencies in recent years, so to what extent is this being accompanied by stronger growth and/or good market returns?

Banxico, the Mexican central bank, was arguably late to begin hiking interest rates in response to rising inflation but has pushed through 725bp of hikes since June 2021. Inflation, which peaked at 7.7%, is now declining sharply, with CPI of 6.3% in the year to April. The bank’s monetary policy comments show a shift to a more neutral interest rate stance for the rest of the year.

These interest rate hikes have not prevented a period of strong economic growth in Mexico. GDP growth in the first quarter of 2023 surprised positively at 3.9% YoY, and consensus forecasts for 2023 Mexico GDP growth have been steadily revised upwards. Consumer confidence is around the peak levels seen in pre-Covid 2019 and both exports and remittances from overseas citizens are at record levels.

This economic growth has fed through to the equity market. Earnings growth has been strong, consensus earnings estimates have been steadily revised upwards and, in USD terms, MSCI Mexico has substantially outperformed emerging and global equities over the last three years. The portfolio has benefited from being overweight in Mexico and it is an example of our philosophy and process working.

The Brazilian central bank has been more hawkish than even its Mexican peer, beginning lifting policy interest rates in the first quarter of 2021 when Covid was around its peak in Brazil. BCB increased the policy rate from 2% to 13.75% in two years, driving a powerful disinflationary process. CPI inflation has declined from over 12% in April 2022 to 4.2% a year later. With real interest rates approaching 10%, it is not surprising that the Brazilian real has strengthened in real terms, but also not a surprise that growth has slowed. GDP growth in the first quarter reached 4.0% YoY, a substantial positive surprise, while consumer confidence has also picked up strongly.

Brazilian equities have had more volatile relative performance than Mexican equities, outperforming emerging equities over the last three years, but slightly lagging global equities. One of the main reasons for this was weakness in Brazilian assets around the 2022 election. Nevertheless, the portfolio has benefited from being overweight Brazilian equities.

Looking forward, in the next twelve months markets are pricing in about 175bp of rate cuts in Mexico but 300bp in Brazil. With the growth dynamics in both economies, with strengthening currencies and with earnings growth coming through, the impact of interest rate cuts should be to accelerate growth and to allow equity markets to rerate, further supporting the self-reinforcing positive cycles we see in both markets. We remain overweight in both Mexico and Brazil in our portfolios



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