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Latin Market Outlook

(Latin America Advisor) — Emerging markets, including markets in Latin America, fell on Friday amid concerns of a US economic slowdown and wider political jitters. What is the outlook for Latin American markets, especially in the event of an economic "hard landing" in the US?

Jonathon Flott, Senior Economist for Latin America, Africa and the Middle East at General Motors: While several recent signs have emerged that selected countries in Latin America will see growth moderate for the balance of 2006 and in 2007, the overall picture remains quite positive, as we expect commodity prices to moderate, not crash, easing pressure on consuming nations without hurting producing nations. The impact of a hard landing in the US would certainly be significant, especially for markets like Mexico, but we don’t see this as the most likely outcome. Importantly, Latin America has recently seen a growth in trade with China and the rest of the world, which will reduce the impact of a US downturn. Additionally, Latin America has largely completed its election cycle for this year, with generally positive results. The Brazilian, Ecuadorean, and Venezuelan elections remain, but only Ecuador seems likely to surprise. While weak second-quarter results have heightened caution and the country continues to struggle with an overvalued currency, Brazil's outlook only moderated slightly. Chile has seen some moderation in its outlook, as copper prices have eased, but growth should remain relatively strong. For both Mexico and Peru, a positive electoral outcome has led to an upgrade in their outlook. Importantly, most countries have also adopted more prudent fiscal policies, best exemplified by Chile's copper fund, to ensure that shortterm commodity windfalls can be captured and saved for the inevitable rainy day. Those countries, like Venezuela, that continue to ignore this step, leave themselves most vulnerable for a future downturn.

John Williamson, Senior Fellow at the Institute for International Economics: Markets should react to changes in expectations, and since there are big returns for being at the front of the curve, small changes in expectations can have large and rapid market effects. But that does not mean that the prospects of the economies in question are changing by similar magnitudes. Most of the Latin American economies look in a good position to avoid any crisis, especially in the short run. That is not for a moment to claim that their economies are now where one would like to see them, with strong growth prospects, let alone with signs of much change for the better in the distribution of income. It is simply to recognize that they have made reasonable progress in crisis-proofing their economies. The prospects of a crisis are even less if other countries' growth, in Europe in particular, is accelerating, so that a slowdown in the United States does not lead to a world recession. Matters will be far more serious if and when there is a loss of confidence in the dollar, as markets start to worry about reluctance to take the measures that would over time diminish the US current account deficit. That is all too likely to produce a loss of momentum of Latin American exports and therefore a sympathetic recession in the region. But the evidence suggests that it is too soon to have to worry about that.

Ricardo Amorim, Head of Latin America Research at West LB: I see the current market correction as an opportunity to build long positions on Latin American assets. The current market sell-off has been caused by concerns (Thai coup, Hungary's political turmoil, and risk of debt default in Ecuador) in emerging markets that expect to fade soon.What concerns me is a sharper than expected US slowdown, which markets have not priced in yet. Eventually, when they do, Latin American and global markets will experience a much sharper correction. Nevertheless, with US equity markets trading close to recent highs and oil prices at the lowest since March, a sharp increase in risk aversion seems unlikely right now. Thus, it makes sense to look for opportunities to go long on cheap Latin American assets, especially where domestic fundamentals rather than external conditions will be the main market drivers. Ecuadorean external debt and Brazilian local rates are two examples. In Ecuador, despite Rafael Correa's emergence in opinion polls, the odds he wins in the first round are slim. Most likely, Correa will face Leon Roldos in a second round run-off and lose, as moderate electors join forces against Correa, similar to what happened in the Peruvian elections. In Brazil, where the Selic rate stands at 14.25 percent, market expectations for the 2006 IPCA fell to 3.03 percent as compared to an inflation target of 4.5 percent. IPCA expectations for 2007 are also below the 2007 inflation target. With Brazil having the highest interest rates and the lowest GDP growth rate in Latin America, there is plenty of room for rate cuts.

Vladimir Werning, Vice President at J.P. Morgan Chase & Co. :  A US 'hard landing' remains a less than likely event, but it should be acknowledged that until the residential housing adjustment is perceived to stabilize the fear will persist; and near-term activity risks are skewed to the downside. In the region, the evolution of presidential polls in Ecuador will remain a source of concern for markets, and the continued judicial blows to the PT's leadership in Brazil leave Lula worse positioned to support reforms in a likely second term. Thus, rough market conditions are likely to prevail for Latin markets even as regional fundamentals remain strong. The impact of a US hard landing for Latin America would be two-fold. First, it would trigger risk-aversion and an unwinding of crowded local market carry trades (particularly Brazilian rates), promote weakness in regional currencies (particularly in economies linked to the US IP cycle, like Mexico and Chile), and weakness in external debt of high-beta credits (particularly, Argentina and Ecuador). Since most regional central banks have been buying US dollars to avoid appreciation of their currencies, they could dampen some of these pressures by simply scaling back their currency intervention. Second, fear of a US hard-landing scenario could put fundamental downward pressure on commodity prices that would imply a negative terms of trade shock for the region and prompt downward revisions to growth expectations, which in turn would hurt equity markets while leading to a steepening of local yield curves. This would be more pronounced in economies that export oil (Ecuador, Venezuela) and metals (Peru, Chile), while agricultural exporters (Argentina, Brazil) should suffer relatively less (alongside economies that have best managed the windfall like Chile.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter.

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