Logic and recent experience say that when U.S. interest rates rise, Latin America falls under the cosh. That is, after all, what happened in mid-1994, when the markets recognized that the
Federal Open Market Committee
was engaged not in a mild snugging operation but an aggressive attack that would ultimately add 300 basis points to the fed funds target rate.
But though the Fed's current tightening mode has clearly become more than what investors initially expected -- with forecasters expecting at least another half-point to be tacked on by midyear -- most Latin American economies are poised not only to weather the tightening, but to continue to blossom. Bourses in the region may run into a bit of a rough patch, however.
"People are fully aware of tightening, even 50 basis points. The Fed will be reversing what is a usually liquid time, and turning the liquidity tap off may be enough to cause Latin America to stutter a bit," says a Latin American equities trader.
But a small correction, even 10% after last year's bull run in local markets, won't result in the kind of crises seen in 1994, when Latin American markets were badly hit, with Mexico dropping by 40% in dollar-adjusted terms. And this despite the suggestion that Latin America's stars look awfully similar today as to how they looked then. As in 1994, Latin American local markets are surging, the U.S. is booming and Mexico is signing a free trade agreement and preparing for elections.
Deja vu, you say? Not by a long shot. For starters, a U.S. rate hike -- even a single shot of 50 basis points -- would not be unexpected, as was that stark series that started in February 1994. Chiapas is no longer erupting, Mexico's former President
and his one-man rule left long ago, this year's Mexican election is not soiled by assassinations and fixed exchange rates have been scrapped in all but a few countries.
Argentina and Brazil may see some short-term effects, but overall fundamentals have improved. Inflation has been tamed in most regional economies and GDP growth is expected to be 3% to 4% this year after 1999's 0.3% contraction. Exchange-rate adjustments, tighter fiscal budgets and more restrictive monetary policies have all led to greater long-term economic stability, a sort of weatherproofing from external shocks.
The world, not just Latin America, is improving economically. As a result, capital flows to emerging markets are not expected to slow dramatically, if they slow at all, after the expected Fed hikes.
That's the soft-landing scenario. If the Fed hikes are larger or have a greater-than-expected impact on U.S. equities and the economy, Latin America will feel the pain.
"If a hike slows the U.S. economy or leads to a sharp decline in equities, there may be some effect," says Michael Hartnett, senior international economist at
. "The Brazilian market is more linked to the
than the bond market." He adds, however, that rates are not likely to reach "punishing levels" with capital flight -- though it must be recognized that Merrill's U.S. economists are among the most dovish on the Street.
But in any deep-tightening scenario, Josh Feinman, chief economist at
Deutsche Asset Management Americas
, warns that the U.S., more than any other country, is the most vulnerable to continued Fed tightening. "Most other economies have still quite a bit of slack -- noninflationary room to grow, largely because they have been so sluggish for a while," says Feinman. "The U.S. doesn't have that. It is straining against capacity constraints, particularly in labor."
The consensus, however, is for a soft landing in the U.S. -- and therefore most of the world. But for that to happen, Fed Chairman
must pull off the delicate trick of cooling off the U.S. without slowing the pace of the world's emerging markets. It's a balancing act that investors, domestic and international, are banking on.