The same investors fail to note, however, the important structural and qualitative changes that have occurred which make the parallel imperfect to say the least.
In 1994 Mexico was running a current account deficit of around 7 per cent of GDP while trying to protect a fixed exchange rate. However, in 2004 Brazil ran a current account surplus of 1.9 per cent GDP and a trade surplus of $33bn and Mexico is enjoying high oil prices and remittances from Mexicans living in the US. Second, in 1994 most Latin currencies were fixed, but now all major economies have floating currencies. Third, in 1994 valuations were at a premium to developed markets but now they are at a discount. Fourth, in 1994 the speed and magnitude of US tightening surprised markets. Today the Fed has made it clear in both its actions and statements that monetary policy is too accommodative and will continue to be tightened.
Moreover, the relative volatility of emerging markets in general has rarely been this low and it seems sensible to assume that volatility is more likely to increase than decrease in the short term. Second, a movement in US rates from 2.75 per cent to say 4 per cent represents a significant percentage change and does represent a relatively large degree of tightening. Given how important the so called “carry trade” has been, in which investors have borrowed money in the US and invested it in high yielding emerging markets, it is sensible to assume that investors will re-assess the risk/reward of this strategy and perhaps unwind existing positions.
However, while Latin American markets ignored the risk of higher US rates, the good news is that Latin central banks did not. Central banks across the region have acted pre-emptively and sensibly. For instance, Brazil began tightening in July 2004 since then Brazilian rates have risen from 16 per cent to 19.75 per cent.
Jules Mort, fund manager of Threadneedle Latin America Growth Fund
