See the potential and take stock of the region’s economic and political prospects for 2023.
Nur Cristiani, Head of Latin America Investment Strategy
Franco Uccelli, Senior Emerging Markets Economist
Xavier Vegas, Head of Global Credit Strategy
Federico Cuevas, Global Investment Strategist
We expect 2023 to be a year of consolidation, with the most anticipated recession in history hitting the US by the second half of the year. However, even as the global growth outlook deteriorates, not all regions will fall equally.
From a macro perspective, LatAm growth surprised to the upside in 2022, despite high inflation and central banks in tightening mode for most of the year. Pretty much across asset classes, LatAm outperformed other regions, both in EM and DM. While the macro outlook should deteriorate, the region can continue to be a (relative) bright spot for investors, as we noted in our global 2023 outlook.
On one end, growth is expected to slow significantly. This would be welcome news from an inflationary standpoint, yet inflation will remain above most Central Banks´ comfort zones, until well into 2024. Furthermore, there is risk of fiscal deterioration driven by political and social pressures as growth fails recover to pre-pandemic levels and social inequality becomes even deeper.
Despite the bleak outlook depicted above, LatAm stands out from across EM as major Central Banks in the region should start to ease monetary policy and thus softening the blow to growth stemming from a global slowdown. Furthermore, supportive commodity prices could also offset some of the impact, as China´s economy reopens post COVID lockdowns. Structural shifts such as nearshoring should also support FDI and hence help keep current accounts in check.
With a focus on the six largest LatAm countries (LA6)—Brazil, Mexico, Argentina, Colombia, Chile, and Peru— in this document we leverage our Global Outlook 2023: See the potential and take stock of the region’s economic and political prospects for 2023, as well as of investment opportunities that it may offer in some key asset classes.
Our highest conviction recommendations remain traditional fixed income and capitalizing on dislocations from a valuation angle through gaining exposure to US small & mid caps and defensive sectors such as healthcare, with alternatives adding diversification benefits to portfolios. The US remains our preferred region given its more defensive profile, yet as the cycle progresses, EM will pick up relevance and LatAm should be key part of those conversations.
Given relatively high real rates, FX in the region should be (relatively) better positioned to outperform in an environment of weaker USD. On the credit side, LatAm corporates are better suited to manage a global recession than most US HY issuers, yet we continue to favor DM IG given depressed valuations for the latter. Finally, on the equity side, the advent of the USD peak could drive flows into EM as growth differentials widen. Given current valuation multiples and relative macro fundamentals, we believe Brazil and Mexico could capitalize on the move.
- LatAm economic growth is poised to slow considerably, dragging inflation down in 2023 despite it remaining above official targets until 2024.
- Interest rates are apt to peak in early 2023, yet stay in low double digits through the end of the year.
- Fiscal deterioration is in the cards for 2023 amid lower economic growth, increased social spending, political pressure, and higher borrowing costs.
- Nearshoring and commodity exposure, coupled with attractive valuations across asset classes, should remain supportive of LatAm financial assets.
After experiencing a deep contraction in 2020 prompted by the pandemic and ensuing economic crisis, Latin America recovered in 2021 and early 2022 underpinned by a more supportive external backdrop. But global winds are now shifting, and they seem to be shifting fast. Amid persistent inflation, tightening global financial conditions, and rising financing costs, the world economy is quickly weakening, commodity prices are softening, and capital flows to emerging markets are slowing. The combination of these factors will make for a challenging 2023 for LatAm, with growth expected to decelerate substantially and print well below potential.
Growth is set to decelerate to a crawl
Although recent developments in LatAm have been greatly impacted by two global shocks, the pandemic and the war in Ukraine, a third development, the tightening of financial conditions, is now increasingly shaping the region’s near-term outlook. Following a sharp 6.6% contraction in 2020 as the world suffered from the worst effects of the pandemic, LatAm’s economy rebounded strongly in 2021, boosted by the global recovery and a surge in commodity prices, and grew 6.6%.
LatAm will grow below potential
Real GDP % change y/y
LatAm real GDP growth
% Change real LatAm GDP y/y
Inflation will be halved, but from a high base
The swift response of LatAm central banks, which began to hike domestic interest rates much earlier than other regions, to surging inflation has helped most of them to contain rising price pressures and to keep long-term inflation expectations relatively well anchored. Except for Argentina, where consumer prices continue to rapidly increase, it is estimated that inflation has already peaked in the rest of the LA6 countries and will gradually recede going forward.
LatAm inflation has likely peaked, moderation is underway
% Change oya, average
Inflation forecasts and targets
% Change y/y
Interest rates are likely to peak in early 2023, but remain relatively high
Shortly after inflation started to rear its ugly head in 2021, and earlier than in other regions, LatAm central banks began to hike interest rates to contain undue consumer price pressures. Although the agility and intensity with which monetary conditions were tightened has helped to contain inflation, the struggle in the region is by no means over. Only two of the LA6 countries, Mexico and Peru, have managed to maintain inflation in the high single digits at its peak, with three others, Brazil, Colombia, and Chile, keeping it from breaking the 15% mark, and Argentina, the exception on many fronts, likely to see it climb to triple digits by early 2023.
LatAm rates will remain relatively high
Reference rate %
Policy rate forecast
%, end of period
Key fiscal deficits are poised to widen, as financial costs stay elevated
The LatAm regional fiscal deficit widened significantly to 9.1% of GDP in 2020 as governments sought to shield their economies from the severe impact of the pandemic and the crisis it produced. Although meaningful consolidation took place as growth rebounded sharply in 2021, with the deficit coming in at 4.2% of GDP, further progress at closing the fiscal gap was rather marginal in 2022, and the deficit is estimated to have only declined to 4.1% of GDP.
LatAm fiscal deficit will widen as growth weakens
As growth decelerates markedly adversely impacting fiscal revenues and the various leftist governments seek to deliver on their promises to increase social spending, the regional LatAm deficit is projected to widen to 5.9% of GDP in 2023, with Brazil and Colombia, both of which are aiming to implement tax reforms, expected to print the largest shortfalls. Given elevated financing costs from high interest rates, means putting public debt on a firm downward path in the near term will be no easy feat.
Current account deficits should narrow slightly, in part owing to nearshoring
While lower commodity prices and softer global growth will negatively impact LatAm’s exports, weaker demand for imports amid lower domestic growth should help the region print a slight overall improvement in its external balances. LatAm’s current account deficit (CAD) is estimated to have risen from 1.6% of GDP in 2021 to 2.2% in 2022, but a sizable reduction in the shortfalls of both Chile and Peru should compensate for an increase in Mexico’s deficit to keep the regional tally unchanged at 2.2% in 2023. No LA6 country is expected to register a current account surplus next year. Among the LA6, the smallest CAD will be recorded by Argentina, at 0.6% of GDP, and the largest by Colombia, at 5.0% of GDP.
Current account balances
Potential annual increase in goods exports due to nearshoring
Political pink tide to take center stage
The October 2022 election of Lula as Brazil’s next president put an end to a busy electoral cycle in Latin America that started in early 2021 amid pandemic-induced economic strains. By January 1, 2023, when Lula is set to be sworn in, the six largest and most financially-integrated LatAm economies (LA6)—Brazil, Mexico, Argentina, Chile, Colombia, and Peru, in that order—which together account for nearly 80% of regional GDP, will be led by left-leaning governments. By most accounts, the leftward shift, which has been dubbed the rebirth of a political pink tide in the region, has not been the result of an ideological realignment in favor of statist policies, but rather the product of voter discontent with the handling of the pandemic and ensuing economic crisis by incumbent right-wing governments. Put different, the success of the left in recent elections has been largely the result of a rise in anti-incumbency sentiment in LatAm and not clear support for leftist policies.
Recent elections have made evident that the pandemic has generally deepened, rather than reduced, political tensions and divisions in LatAm, increasing uncertainty and raising concerns about future economic policy direction. Meanwhile, from a market standpoint, the biggest risk associated with the ongoing regional swing to the left of the political spectrum is that it could prompt changes to the laws, regulations, or contracts governing investments in a way that adversely impact their financial returns.
The only LA6 country scheduled to hold a presidential election in 2023 is Argentina, but not until late in the year, with a controversial libertarian economist boasting a strong showing in recent polls and, in some cases, even outpacing his mainstream rivals. The next major general election will be in Mexico, but not until mid-2024.
Calendario electoral 2023-24 de los seis países más grandes de América Latina
Country risks in focus
Although a worsening external environment will undoubtedly cloud LatAm’s regional outlook in the near-term, each country’s prospects and risks will also be driven by idiosyncratic factors. In Argentina, for example, strengthening macro stability, containing elevated inflation, reducing policy uncertainty, and complying with the country’s IMF program will be key challenges. Meanwhile, in Brazil, tight financial conditions are likely to weigh on already soft growth at a time when a weak fiscal stance is expected to be relaxed even further as the new government prioritizes social spending. In Chile, growth is projected to moderate significantly from a low base as the authorities recalibrate monetary and fiscal policies and the possibility of social discontent remains a concerning risk, leading the economy to contract the most in 2023 among all LA6 countries.
Apart from high levels of political risk and policy uncertainty, Colombia’s twin fiscal and current account deficit remains a key source of concern, with growth projected to cool meaningfully as interest rates are kept high to contain the second highest inflation (after Argentina) in the LA6 space. While Mexico’s fiscal policy, a vital source of concern for many other countries in the region, is widely expected to remain prudent, the economy is poised to slow in tandem with the US, the destination of nearly 80% of its exports. Finally, though Peru’s fiscal and external buffers remain relatively large compared to most others in the region, its balance of risks is skewed to the downside owing to soaring political uncertainty.
Corporations in LatAm are better suited to manage global recession than most US HY issuers as they have lower leverage, hold strong cash buffers which limits their need for market access and are accustomed to cutting capital expenditures in a haste.
However, having behaved as if they were issuers of reserve currencies during the pandemic, the Sovereigns are now in a tough situation. Fiscal risk remains relatively unanchored at a time when inflation is peaking, and monetary policy must remain tight to offset fiscal policy. In a flashback to the 1980s the region is regressing to unorthodox fiscal policy which runs the risk of turning into fiscal dominance of monetary policy, further exacerbating currency depreciation and inflation dynamics.
Given this setup, we like corporate bonds of exporters with balance sheets and cash flow generators geared to benefit from a weaker currency within LatAm corporates. We do see a sustainable environment where the currencies will depreciate in spits and spats providing inherent operating leverage to exporters as the fixed costs and variable costs in local currency gets diluted and their topline holds with its hard currency basis.
Commodities are essentially back in vogue as years of underinvestment have led to basically matched supply and demand and marginal growth drives real price appreciation. This serves to support the “exporter’s” thesis as well as the local currency depreciation dynamics.
On a relative valuation, LatAm Corporates and Sovereigns remain expensive to Developed Market Investment Grade bonds particularly on the advent of a potential recession. Our bias is to continue to move up in quality preparing for next year.
Valuation on Spreads and Yields looks attractive in Emerging Markets
Corporate spreads are back to median relative to sovereign spreads offering some value but not recession levels value
Difference (bps): Corporate spreads - sovereign
Sovereign and Corporate Yields in LatAm do not offer relative value to Developed World Investment Grade
Ratio (Latam EM Yield / US IG Yield)
Recent LatAm FX performance has been mixed
Since LatAm currencies typically strengthen when the US cuts rates and weaken when the US hikes them, and the Fed has been in hiking mode since last March, several key LatAm currencies—including those of Argentina, Colombia, and Chile—have depreciated against the USD so far in 2022. A notable exception to this trend has been Brazil, which started hiking rates much earlier and more aggressively than the US, widening rate differentials in its favor.
LatAm FX performance vs the USD
% change YTD
LatAm currencies are apt to weaken in 2023
As most LatAm countries reach peak rates by early 2023 and shift to an easing mode to stimulate their cooling economies amid a global slowdown, and the US keeps interest rates relatively high well into next year, LatAm currencies are likely to gradually weaken by end-2023. In fact, there is not a single LatAm currency among the largest economies that is expected to appreciate against the USD in 2023.
LatAm currencies are poised to depreciate in 2023 (USD/LC)
That said, the degree of depreciation of LatAm currencies will likely be highly uneven, with the currencies of Argentina and Colombia bearing the brunt of the regional decline, while others, like the currencies of Mexico, Peru, Chile, and Brazil, projected to depreciate only slightly.
A quick word on the recent USD strength
Long-term trends in FX are heavily influenced by interest rate differentials. With U.S. rates exceeding those of other key DM countries, the USD has outperformed its DM peers in 2022.
Interest rates differentials have boosted the USD
LatAm currencies are better suited than other EM currencies to be resilient in a challenging global environment
1y carry-to-volatility ratio*
Despite global headwinds and political noise, LatAm equities significantly outperformed the rest of the world and EM in 2022, as of the time of writing. In fact, out of the main regions within EM, LatAm was the only one to post a positive return. Country-by-country, Chile and Peru made it into the top 5 performing countries in spots 2 and 3 and 5 respectively, while Brazil stood in the 6th place and Mexico in the 11th spot.
LatAm’s outperformance comes despite headwinds from higher US rates, a strong USD, idiosyncratic political risks, and persistent high inflation, among other factors. We attribute the region’s equity resilience to a high exposure to commodities, which are still the best performing asset class YTD, as well as cheap valuations and strong growth tailwinds supporting robust companies’ earnings growth. Growth prospects for Mexico and Brazil were consistently revised up this year, despite lingering fears of a Central Bank – driven recession.
2023 Key Drivers and What to Expect
Next year’s political calendar for the region will be significantly lighter than what it was in 2022, with the presidential election in Argentina taking the spotlight 4Q23. This means that main drivers for LatAm equities into the new year should be restricted to (1) foreign investor flow (i.e., global risk appetite), (2) idiosyncratic growth dynamics flowing through to earnings growth estimates, (3) lower rates as tailwinds for valuations that are too cheap to ignore.
Dynamics within the region will vary widely. Valuations across the region are unsustainably low, yet for Chile, Colombia, and Peru, given their markets’ low liquidity, we struggle to find catalysts to reverse the valuation discount. On the other hand, outlook for Brazilian equities seems like a coin toss at this stage. On one end, the BCB is expected to cut rates as soon as mid-year 2023, without impacting the BRL given high real rates. Domestic activity has been well supported and should remain so into 2023. However, fears about fiscal recklessness from the incoming government presided by Lula will cast a shadow keeping valuations below their historical average, especially for SOEs. On the other extreme, valuations in Mexico are also broadly attractive yet growth could be challenged by a recession in the US (our base case scenario). However, we see greater room for re-rating as international appetite reverts to EM as USD weakens and growth differentials across EMs vs. DMs narrow.