Latin America has served as a respite for whipsawed emerging market investors during the first quarter, as accelerating inflation and a more hawkish U.S. Federal Reserve weighed on assets even before Russia’s invasion of Ukraine in late February.
Emerging market performance this quarter has been sharply determined by whether a country imports or exports energy and basic metals, which are key inflation pressure points.
Across the Atlantic and far from the war in Ukraine, Latin American currencies have continued to outperform on monetary policy tightening cycles that began last year and of exposure to key commodities, plus relatively low baselines after the region’s economy was decimated by the COVID-19 pandemic.
Emerging markets stocks have fallen 6.8% this year, dragged by a large exposure to Asia and just shy of a 15% weighting from materials and energy, while developed economy stocks have lost 4.2% for the January-March quarter. Latin American stocks, by contrast, have chalked up a 26% gain, boosted by a near 35% weighting from the materials and energy sectors.
Sameer Samana, a senior global market strategist for Wells Fargo Investment Institute, runs a thematic commodity exporter basket that he said “has been in a downturn since 2012.” “It has tilted back up to an uptrend for the first time in a decade.”
He said the overall emerging markets stock index underperformance is partly explained by its skew toward China, South Korea, and Taiwan. “These are not your grandfather’s emerging markets, they’re a lot less commodity-centric than they used to be, heavily tilted to commodity importers.” said.
The further spike in energy and food prices triggered by the invasion has weighed mostly on Emerging Europe, as the broken trade relations take a toll on the region.
“Spillovers to the rest of Emerging Europe will hit the region hard, particularly Bulgaria and the Baltic States where trade linkages with Russia are among the largest in the world,” research firm Capital Economics said in a note.
Four of the five top-performing emerging markets stock markets in dollar terms in 2022 are from Latin America, with returns from Colombia, Chile, Brazil, and Peru hovering around 30%. Add Mexico to the list, and you have five of the six best-performing currencies this year against the dollar.
The best-performing bonds in local currency include Brazil, Uruguay, Chile, and Peru.
Foreign currency bond yields have risen across developing economies as the Fed’s tightening cycle takes hold, with Turkey and Argentina among those with the smallest total return losses, according to JPMorgan data.
The war in Ukraine and the energy shock
The sanctions against Russia for its attack on Ukraine included bans on oil imports from the United States, the largest global oil consumer, as well as Canada, Britain, and others. The barrel of U.S. crude, which was already up 23% right before Russia’s invasion of Ukraine, is now up 43% for the quarter, the second-largest quarterly gain since 1990.
Among big energy importers, Turkey’s lira has stabilized below 15 per dollar after last year’s crisis, but it’s down near 10% on the quarter, with about half the loss coming in March. But its foreign sovereign bonds rank third-best among emerging markets.
Egypt, a major food importer, devalued its currency by 14% to entice investors that had pulled their cash after the war started. The Egyptian pound is now the worst-performing emerging market currency so far this year.
While Russia’s rouble rallied over the past two weeks, currency controls could be making the rebound artificial. It remains more than 10% lower than the dollar so far this year, while Ukraine’s hryvnia is down over 7%.
The dollar has strengthened 2.3% versus a basket of peers. Emerging markets currencies have ticked up 0.5% to the greenback this quarter, with the Latin America currency index jumping 14% to hit a quarterly record.