The Fed’s Pivot and Latin American Currencies: A Calculated Risk or Repeat of History?
A staggering 65% discount – that’s how undervalued emerging markets currently are compared to the US, according to Eastspring Investments. As the Federal Reserve gears up for a potential interest rate cut this week, a move widely anticipated by markets, Latin American currencies find themselves at a critical juncture. While a weaker dollar typically boosts emerging market assets, history suggests a Fed easing cycle doesn’t automatically translate to gains for the region. This time, however, a unique confluence of factors – synchronized global rate cuts and improving profit prospects – could rewrite the narrative.
The Dollar’s Descent and Latin American Resilience
The US dollar has been on a clear downward trajectory throughout 2025, registering its worst first-half performance since 1973. This depreciation, fueled by concerns over President Trump’s policies and growing expectations of Fed easing, has provided a tailwind for Latin American currencies. However, analysts caution against expecting a dramatic surge. Marcelo Rebelo, chief economist at the Bank of Brazil, emphasizes that the rate cut is largely “widely incorporated in the markets,” limiting the potential for an immediate, substantial reaction. The key will be the pace and depth of future cuts.
Currency-Specific Outlooks: A Mixed Bag
The impact of a Fed cut will vary across Latin America. The Brazilian real (USDBRL) benefits from a favorable carry trade dynamic, potentially allowing for some appreciation, but its historical vulnerability to Fed policy remains a concern. Mexico’s peso (USDMXN) could see support from a widening interest rate differential with the US, according to Citi analysts. However, Monex warns against expecting a “significant movement” in the exchange rate, as much of the impact is already priced in. Colombia (USDCOP) is also expected to see limited immediate impact, with the dollar’s weakness largely factored into current valuations. Chile (USDCLP), however, stands out as potentially benefiting from increased appetite for emerging assets and improved trade terms.
Historical Patterns: A Cautionary Tale
Despite the current optimism, a Bloomberg Intelligence analysis of nine Fed easing cycles since 1995 reveals a sobering trend: Latin American currencies often lose value against the dollar during these periods. The Brazilian real has historically been the most affected, while the Chilean, Colombian, and Peruvian sol have shown relative resilience, albeit with moderate declines. The Mexican peso’s performance has been the most volatile. This historical pattern underscores the importance of understanding the context surrounding the Fed’s actions.
The Rhythm of Cuts Matters
The speed at which the Fed cuts rates is crucial. Aggressive cuts tend to exacerbate losses in Latin America, while a more gradual approach allows currencies to partially contain depreciation. This is because rapid cuts can signal weakness in the US economy, triggering risk aversion and capital flight. As Bank of America notes, most Fed cuts have occurred during periods of economic slowdown, negatively impacting corporate profitability.
Beyond Currency: The Impact on Latin American Equities
The potential for Fed-induced liquidity is also boosting Latin American stock markets. With assets trading at attractive multiples, regional indices have risen by over 50% amidst a rotation of flows into the region. Bank of America highlights the unusual context of a global rate-cutting cycle occurring alongside improving profit prospects, positioning equities as a potential beneficiary. However, Natixis Investment Managers cautions about a “buy the rumor, sell the news” reaction, suggesting any initial rally could be short-lived.
Navigating the Rally: A Strategic Approach
Historically, Latin America tends to rebound within three months *before* the first Fed cut, as investors anticipate the positive effects. If market consolidation or weakness emerges in the coming weeks, Jack Janasiewicz of Natixis suggests it could present an opportunity to increase exposure to risk assets. This proactive approach, combined with a long-term perspective, may be key to capitalizing on the potential benefits of a Fed easing cycle.
The Bigger Picture: Emerging Market Attractiveness
The expectation of lower US interest rates and contained inflation is reinforcing the attractiveness of emerging markets. With real rates remaining historically high, a Fed pivot is seen as a positive catalyst for risk appetite. However, investors should remain vigilant. The sensitivity of each currency to Fed policy varies, with the Brazilian real and Mexican peso exhibiting the highest betas, indicating greater exposure to US monetary policy shifts.
What are your predictions for the impact of the Fed’s decision on Latin American markets? Share your thoughts in the comments below!
