Interest rate hikes are generally bad news - except in this region

Mexico

The Mexican peso at 15 (to the US Dollar) was considered an anomaly and unjustified, while closer to 20 was a more normalised structural level. Ignoring the political influence, the economics look okay, but with greater headwinds ahead.

• Domestic spending has been supported by significant increases in social policies over the last six years and while these will remain in place, the trajectory will slow.
• Investment pipelines could stall ahead of the electoral reform as concerns increase around the security of investment returns.
• The government coffers have been significantly depleted under an AMLO (Andrés Manuel López Obrador, Mexico's former President) government, with a much smaller safety net available to the new administration.
  

Brazil

This was priced into markets and was not a shock to see a 25bps increase on the 18th of September. Interestingly, I think the fact that it was only 25bps disappointed markets hoping for a short, sharp correction to inflation.

Because:

• The driver of a halt in rate cuts and subsequent reversal in trend is stronger absolute economics – interest rate expectations have been increased but buoyant household spending and a resilient labour market have also pushed up GDP expectations, with 2024 GDP forecasts increasing from 1.6% earlier in the year to 2.22% currently. Ultimately, higher activity numbers and GDP, and higher inflation with protection at the asset level, are fundamentally beneficial to infrastructure valuations.
• Strong policy message as the central bank, with political support as discussed above, is strictly adhering to its inflation targets and moving away from a historical ‘loose’ guideline.
• Brazilian interest rates are structurally high due to the absence of domestic saving rates. While the headline looks negative, the actual real interest rate is currently below the historical trend, so a move up brings it more into structural alignment.
• FX appreciation – the expectation of a widening interest rate differential between the USD/BRL (Brazilian Real) due to hikes in Brazil corresponding with the start of an easing cycle by the US Fed and a tightening cycle by the BCB (Brazil's central bank) should favour the BRL in the medium term.

We believe that there will be a short, sharp hiking cycle to appease policy response and get inflation expectations within the band before the trajectory shifts down again into the 2026 election campaign (12 months ahead of the vote). The curve is pricing in an approximately 150bps increase, which is considered the maximum that would be needed.

On 31 August, the budget was released, with the government forecasting a zero deficit for 2025. There were no huge surprises but key elements to note include:

• The spending cap will move from R$2.105 trillion this year to R$2.249 trillion in 2025, providing the government with a circa $144 billion increased spending budget. However, a 6.87% increase in the minimum wage to US$267/month and other mandatory expenditure increases will use up 92% of this increase. This leaves just 8% for discretionary spending including investments.
• An additional R$168 billion in revenue was identified, although sourcing is not that clear with reliance on increased taxes and administrative measures and the buoyant economic outlook.
• Forecast 2025 GDP growth of 2.64% underpinning much of the proposed spending – should it fall below this then the deficit is at risk given this impacts revenue and expenditure limits.
• As a result of budgeted increased interest rates, the forecast inflation is 3.1-3.3% which is only slightly above target and a drop from the 4.5% it is tracking at.

• The increased social allowances support ongoing domestic consumption.
• To ensure the investment they need, the government is going to increasingly have to rely on private sector capital for infrastructure investment – we expect more asset privatisations and greenfield auctions as a result.

Climate

USA

However, it’s worth noting that the historic relationship between emerging markets and interest rate moves has significantly weakened, as dependence on USD debt has dissipated and monetary policy decouples. As such, the fundamental shift from a cut in Fed rates will be less visible than historic rate cycles.

Global

This has national ramifications for economic growth, export chains and, importantly, infrastructure investment. The other global theme widely discussed was decarbonisation and how the region could play a role. 

We hear a lot about the US, and the EU’s large green packages and financing of their energy transition. However, Brazil is already where it wants to be in around 20 years: 90% of its power matrix and almost 50% of its energy matrix are already coming from renewable sources of energy. 

According to McKinsey, Brazil has the potential to become one of the first countries in the world to achieve net zero emissions working towards a 2030 goal. 

The opportunity extends beyond domestic borders, with Brazil’s potential to export clean energy and low-carbon products supportive of a multi-decade growth theme for the Brazilian economy. This includes:

• The ability to manufacture products with a lower carbon footprint, such as cement and steel.
• Being a large global producer of biofuels, a competitive advantage in terms of sustainable aviation fuel production.
• Biomethane production is gaining traction, utilising biomass generated in agriculture activities (itself growing) and also through waste decomposition.
• Ethanol production and export.
• Having a stock of critical minerals including nickel, lithium, graphite and rare earths.
• Potentially evolving as a data centre hub given power security.

According to a recent report by the Boston Consulting Group, Brazil is strategically positioned to lead climate solutions on a global scale, with the potential to attract between US$2.6-3 trillion in investment by 2050.