LatAm Es Muy Caliente Now

Monetary policy is also tight, and the strength of the Brazilian real is also both a reflection of tight monetary policy as well as tantamount to monetary tightening in its own right. The overnight interest rate stands at 19.75%, even though inflation hit a 13-month low of 6.6% last month. The high real interest rate (interest rate minus inflation) and slowing growth will likely allow the central bank to begin cutting interest rates probably starting next month. The overnight rate cut may fall by 100 basis points or more by the end of the year.

Mexico is also experiencing a growth slowdown and easing inflation pressures, and this will likely lead the Bank of Mexico to reduce rates as early as next month.

The second-quarter GDP was reported earlier this week and it was disappointing. The Bloomberg consensus had expected 4% growth and instead 3.1% was reported. Part of the disappointment was a function of the drag from the U.S. industrial sector and especially the auto sector. Auto output accounts for about 15% of Mexico's manufacturing and the woes of U.S. car manufacturers took its toll.

The slowing economy has also seen price pressures ease. In fact, the outright decline in inflation in May and June was the first consecutive monthly decline in consumer prices since the central bank began tracking them in 1969. The central bank forecasts inflation to be below 4% by year-end, and they are clearly on track to meet this goal.

The risk is that Mexico and Brazil may begin to reduce rates, then the peso and real would begin giving back some of this year's gains as traders unwind positions and realize profits. Lower interest rates could help boost the local stock markets, but this is not a foregone conclusion.

With great returns come great risks. There is no free lunch, not even in Latin America.

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