Global Macroeconomic Outlook – with insights on Asia and Latin America

Roman Dubczak: Hello, everyone. I’m Roman Dubczak, Deputy Chair at CIBC Capital Markets. Thanks for joining us for another Perspectives webcast with today’s focus on global macroeconomic conditions. As we approach the end of the calendar year, forecasters are already looking ahead to the state of politics in the economy in 2024. With geopolitical uncertainty and volatility at generational highs, setting business strategies today is vastly different than it would have been in the recent past. This time last year was a radically different scenario than where we find ourselves today. The degree of dialog that our team at CIBC is engaged in with our clients on the state of the world has never been higher. Today, I am joined by my colleagues from the Fixed Income Currencies and Commodities Strategy Team to give us their perspectives on the shifting global markets. With me in the studio is Bipan Rai, Executive Director and Global Head, Foreign Exchange Strategy, Global Markets, and Luis Hurtado, Director of Global Markets, And online, I’m pleased to introduce Maximilian Lin, Executive Director, Global Markets, who recently joined CIBC in October. Max is located in Singapore and is responsible for Asia-Macro and Currency Strategy. Welcome to CIBC Max, and welcome everyone. Okay, Bipan, let’s start with you. Give us a global perspective on the foreign exchange markets before we dive into the various regions.

Bipan Rai: Yeah, so this is an interesting time for a foreign exchange market as a whole because if you remember the last couple of years, I mean, we’ve been, obviously the talk has been about the accelerated path of tightening for buy taken by central banks, particularly the developed market space. Now we’re getting to a point where all of the central banks have the similar message. We’re at steady state. Our policy settings are restrictive enough and now we have to pay attention to when they’ll start cutting. And this is the point at which we start to see some divergence when it comes to monetary policy and we start to see certain central banks start to ease before other central banks. And that’s important for the foreign exchange market, especially when it comes to divergences and the like. And this is the time which we really do need to pay attention to idiosyncrasies within each market. And those, of course, include two factors that we’re watching, the stock of household debt held by each country, and of course, the structure of the mortgage market. And we think those are going to be very instrumental when it comes to really understanding or extracting the degree to which monetary policy lags in each economy. Of course, when you raise interest rates and then that passes through to real activity, it’s not like a light switch. There’s usually a bit of a lag. But at this point this is going to start mattering more. And this is the point at which we think that foreign exchange volatility is going to pick up meaningfully. And we do think that clients are going to need to be particularly attuned to those risks going forward.

Roman Dubczak: I agree that the scenario of rate cuts is prominant and I spent quite a bit of time on my Bloomberg terminal this morning looking at all the probabilities as to, what the different scenarios are into next year. But why don’t we dive in a little bit deeper? Perhaps touch on why we should be focusing on the certain regions and the differences between the regions, namely Latin America and China?

Bipan Rai: Absolutely. I’ll start off with China because it does occupy a central role when it comes to the global macro. And of course, you know, we have seen a pronounced slowdown there and there’s been some cyclical decoupling from the rest of the developed market space. So it’s important from that lens, but of course, we should also remember that there are a lot of companies here in North America that do rely on China and do rely on Latin America as business partners. So gyrations of the exchange rates will be important factors for them to consider over the course of the next 12 to 24 months.

Roman Dubczak: Yeah, Luis, from a Latin American perspective, what are the themes that you think will dominate FX action in the next year?

Luis Hurtado: Hello Roman. In Latin America, there will be two themes next year. The main theme will be, and I will put them in the same bucket. The Fed’s monetary policy stance and the monetary policy easing started by Latin American central banks during the first half of this year.

Roman Dubczak: Yeah.

Luis Hurtado: I will point out the one common denominator in across LatAm has been starting the easing cycle earlier than most central banks in the world. In that sense, we expect this instance to continue into 2024 and in fact, we expect substantial rate cuts next year. In the lower end, we expect the bank to cut rates by 225 basis points, while in the high end we expect the central Bank of Colombia to cut rates by 475 basis points. Now, if we move into the Fed’s monetary policy stance, I would point out that any change towards a dovish narrative by the Fed could accelerate the pace of rate cuts by Latin American central banks into, especially the second half of next year. This is quite important for LatAm FX, as the current easing base for these currencies, we have tended to see Latin American FX total return, post negative values during periods in which the Fed has been cutting rates. And on the second bucket, and this is more related to the story in China, we expect to see the real and the Chilean peso remaining under pressure into early 2024. While for the peso, the most important themes will be what happens in the US labour market and what happens to manufacturing exports in Mexico.

Roman Dubczak: Yeah, on a related theme and in specific in the case of Mexico, a lot of attention has been put on the remittance growth into Mexico as one of the main drivers of the peso’s strength. So given what you just said, what do you think the main risks are for the peso next year?

Luis Hurtado: First, I don’t think that remittances are going to be one of the main drivers for the Mexican peso next year. And in fact, I expect them to be a headwind for the Mexican peso. For instance, our research shows that a mild three percentage points increase in the unemployment rate for Hispanics could lead to a 10% decrease in remittances to Mexico next year. This is quite important for the Mexican peso, since remittances account for nearly 60% of total dollar flows into the country. Now, other routes that I’m currently looking at is the performance of the manufacturing sector in Mexico. And here, I would point out, that similar to remittances, this sector is quite sensitive to higher interest rates in the US. We have already seen non-vehicle manufacturing exports posting year-over-year declines, while, I will point out, that the strong performance of vehicle exports has responded to the pent up demand in the US, but we expect this to dissipate quickly into 2024 as savings get depleted there and high interest rates persist.

Roman Dubczak: Okay. In the case of Brazil, it appears as though they finally managed to prove a new fiscal role in 2023. But the latest comments from President Lula suggest that the 2024 budget will need to be modified. What’s your call on how this is going to go forward?

Luis Hurtado: I think there are two ways this is going to go forward. One way is through the current discussions in Congress, they could still modify that target into next year, but the most likely will be a separate bill next year. And this is because the government is pressing Congress to approve some revenue measures. But given the latest comments by President Lula against cutting expenditures in 2024 and the lack of support for final revenue measures, I expect the government to submit another bill next year changing the target. Now, for the markets, this is quite important since we have been running under the narrative that debt-to-GDP was going to stabilize in the next three years. This is no longer true. And two other points. One, Lula is quickly losing political capital and we don’t see revenue measures going through Congress anymore. And two, and this is the most important part, it signals the lack of respect from either side of the political spectrum for fiscal targets or fiscal rules in Brazil. And this is quite negative for the Brazilian real despite it’s carry.

Roman Dubczak: Yeah, sounds like lack of respect for fiscal role is a global phenomenon. But the Colombian peso was very strong last year. and the Chilean peso depreciated significantly. For 2024, how do you see the relative performance shaping up?

Luis Hurtado: Well, I expect this performance to continue for the first quarter of next year. However, I see a reversal beyond Q1. On the Chilean peso, there are two significant developments. The first one is that we move into the ratification vote for the new constitution, having two market friendly options in the table. The newly drafted constitution was drafted by centre-right and right political parties. And the alternative, which is the current constitution, is also market friendly. So from that point of view, I don’t see any significant pressures on the Chilean peso beyond some residual noise at the end of the year. Another significant factor, and this is in favour of the peso has been, the central banks signaling they are going to support the Chilean peso going forward. And the latest minutes suggest that they see the depreciation of the peso, not being driven by any fundamentals. And that discrepancies between what has happened in the rise of the LatAm and the Chilean peso is quite worrisome for the Chilean central bank. I suspect the Chilean central bank will continue to support the peso, the slower pace of rate cuts, or via verbal intervention as they did in the October meeting.

Roman Dubczak: Okay.

Luis Hurtado: For the Colombian peso, two main factors that supported the currency last year. One of them is, the government quickly losing support in Congress. And two, the cautious stance by the central bank for most of 2023. This is not going to continue next year. And in fact, the latest comments by the central bank board suggests an unofficial bias towards cutting rates sooner rather than later. And the latest inflation numbers point that we can suggest we can see these cuts starting as soon as December. And in the political arena, I don’t I don’t expect Petro to become a lame duck. And I see increasing risk of further populist measures such as pausing the increase in fuel prices and larger than expected increases in the minimum wage for the next year.

Roman Dubczak: Okay, very good. Thank you, Luis. Max, let’s turn to China. Obviously, a lot going on there. An understatement, no doubt, but we’re facing an ongoing property crisis which has been going on for a while and likely continues, in the context of that and a variety of other things going on in China, how is the government plan to achieve its growth targets for next year?

Maximillian Lin: Sure. Well, as you point out, it’s been going on for some time, the property crisis in China. And I think there’s a good reason for that. And the reason for that is, the response in this particular property crisis has been very incremental in terms of policy easing in order to boost growth. As market participants, that can be frustrating. You know, we’re always used to very strong Chinese growth and we’re always very used to China, you know, rebounding to 7-8% growth, sometimes more even after large US recessions, because of that historical fast response to crises in China. But this time is different because, China’s leaders, President Xi Jinping in particular, are now very cognizant of previous bouts of what we call “flood-style stimulus” and the side effects that those had on to the long-term leverage in the system, right? So, when I say “flood-style stimulus”, I’m really talking about unrestrained debt spending to basically grow and bounce back as fast as possible. And we saw that in 2009 and 2010 in China. That only adds long-term leverage risk in the property sector, which authorities will have to clean up at some other time. So they’re going to want to avoid that. So they’re basically going to keep easing very gradual and targeted and hope that over time, or not ‘hope’, but basically coax the animal spirits in China back out of their caves and into the active economy. That will take time, obviously. But the leaders are still making strides towards that direction. With housing itself, it’s also important to keep in mind that, President Xi Jinping basically started clamping down on property in 2021 because he had housing affordability in mind. And affordability still a long goal for the president. It’s part of his Chinese dream that he’s been talking about. You need to keep middle class housing affordable in order to usher this new generation of Chinese into this era of common prosperity. The issue that China has now is how to make that adjustment towards more affordable housing without too much pain for existing homeowners and without too much pain for the healthier property development companies that weren’t quite as reckless. So we’re seeing some good signs on the Chinese front. We did see news of a new $130 billion US PSL, a Pledged Supplementary Lending facility. That’s a long-term facility that’s targeted at housing, but housing that’s meant for first time home buyers and meant to renovate older inner city villages within these larger tier 1, tier 2 cities. So, it’s easing, but it’s targeted easing. And, again, the the trickle down is being very deliberate here. For growth, that might mean a slower growth target next year, maybe four and a half percent, maybe somewhere just below five. But I think that the government is happy with accepting a slower growth rate as long as that common prosperity is, as long as the ‘quality growth’, is being met.

Roman Dubczak: You know, an interesting comment I heard just the other day was, it’s as you mentioned, first time in our careers, things that have happened, the US growth rate and the Chinese growth rates roughly the same in the last quarter. It’s quite remarkable. Just, you know, when you talk about housing in China and the issues regarding the property sector, are there any concerns regarding the banking sector we, kind of, need to keep an eye on?

Maximillian Lin: From my perspective, not quite. And I think the reason you have a big difference between, let’s say, the US housing crisis in 2008 and the current Chinese crisis is that, it’s very difficult to have a Chinese systemic banking issue when all of China’s largest state banks are partly or majority owned by the state. And, when you think about sovereign leverage and the sovereigns ability to back the banking sector, China’s overall debt-to-GDP is pretty low at just 77% of GDP. That compares to 120% in the US and around 107% in Canada. So, if there are losses in the banking system, and I have no doubt that NPLs will rise, the government is already basically owning the banks and has the ability to inject more fresh capital should that need arise. For financial markets, actually I think the good news now is that authorities have made market stability and currency stability an explicit policy. So in mid-November, the People’s Bank of China, the central bank, issued a statement noting that it will implement policies to stabilize market expectations and that it will prevent the risk of large fluctuations in the yuan exchange rate. So now it’s basically being very explicit. We did see reports in October of China’s Sovereign Wealth Fund buying ETFs in the Chinese equity market in order to support equity valuations. Since September, the CNY Fix, which sets the daily trading band in the yuan exchange rate, has been very stable. So we already knew that the government was intervening in markets. Now it’s an explicit policy, which should help keep depositors, foreign investors from panicking any further, in terms of the China property crisis and what it means for the financial system.

Roman Dubczak: Great. Given today’s context, any comments regarding the yuan, and issues our clients should be aware of?

Maximillian Lin: Yeah, I do think that the red line for China when the dollar was strengthening, and if we do see another bout of dollar strengthening if Fed expectations get repriced after this recent weak US CPI mixed retail sales data is that if the dollar does rise again, I don’t think that the yuan will weaken past the 737-740 level versus the US dollar appear to have been the red line back in September or October. And I do think that it will be the red line throughout next year. We are seeing strength in the yuan after the US CPI rating, so we’re seeing it around 724-725. I do think that it won’t get that much stronger because, as China’s growth remains weak, and there is some hope for a tech export rebound on AI demand, China will want to keep the yuan very competitive. So I don’t think they’re going to allow too much depreciation against the US dollar further.

Roman Dubczak: So Max, the topic of US-China tensions is obviously top headline everywhere. What can we look for in terms of the current discussions and the shape of the US-China relationship going forward?

Maximillian Lin: I mean, with all the negativity on China’s economic outlook, I think the silver lining we could take away from that as investors is that the Chinese government now realizes it does need a little bit of outside help to boost growth. And that’s why President Xi Jinping and Chinese leaders have been engaging more with Western countries to try to, you know, sell them on the idea that they’re still allowed to do business in China, that China’s still a great place to do business. It’s a great place to invest in factories, a great place to open offices. So, President Xi Jinping will be meeting with Biden in San Francisco, as you point out, at APEC, and he will be having another follow up dinner and meeting with US corporate leaders. And I do think that the most important thing to pay attention to is the tone, right? He’s no longer really criticizing US policy, even in state media back home in China. And he’s basically trying to emphasize the values that China does bring to those companies. And that automatically means that there will be, you know, less sorts of things like police investigations to foreign offices in China that we saw, you know, in the previous 18 months or so. So that’s definitely the number one thing I will take away from it in terms of core issues that China has and the core rivalry with the US, things like Taiwan, things like Hong Kong, things like self-sufficiency in high tech areas like AI computing, high tech chips, those all will remain core areas, but the government is going to try to shift the conversation away from that. And I think just that shift in narrative on its own is more constructive for the relationship, because although it’s a rivalry that the US and China want to manage, they’re no longer shouting at each other. They have a list of things to work through and they’re working at it in a more pragmatic fashion. And I think that’s what we will see.

Roman Dubczak: Yeah, like well said. That said, the fact that they’re not shouting at each other any longer, the concept of on-shoring in the case of the West is something which I think continues. I think collectively that’s a view that that’s going to continue. Which economies do you think are going to benefit most from the friend-shoring or the de-globalization?

Maximillian Lin: Sure. Well, there has been a US pivot to Asia and we’ve seen, you know, the US trying to engage more with India, with ASEAN. So countries like Indonesia, India, Vietnam, I do think can benefit in the long-term from this economic engagement that the US is having. But in terms of overall reshoring or friend-shoring, you know, this has been a hot topic that’s been debated since Trump escalated tariffs in 2018. So it’s been about five years. And I definitely think it’s an important discussion that boardrooms and C-suites need to have when they think about their long-term supply contracts. But what I want to remind everybody is that China’s still has a lot of in-built advantages that kind of cements its competitive position.

Because even though we’ve been talking about reshoring for the last five years and even though we had a global pandemic, China’s exports to the US and China’s trade surplus to the US, has actually grown to a record level since then, right? Even though there’s been this conscious effort to reshoring away from China. So that’s just a reminder to me that even though you do hear anecdotal evidence of companies relocating their factories from China or thinking about opening of a factory in India, there’s so many in-built advantages in China that make it difficult for the world to completely turn away from China, right? We hear a lot more about large US tech firms wanting to build factories in India, automobile factories, chip factories. But for the time being, it’s very hard for India to match China in infrastructure. Things like power plants, ports, railways, which are all critical in having an efficient global supply chain. So I think India, Indonesia, Vietnam, they we have a long-term potential in these areas. But on the infrastructure side, particularly for India and Indonesia, they’re not quite there yet. You still need considerable more investment dollars and more time before they can really match China from that perspective. And I also want to add that some of this manufacturing, the low end manufacturing is business that China is happy to give up as the country gets richer, as the exchange rate gets stronger over the next ten years. Similar to Japan’s transition in the 70’s and 80’s, the country eventually will become advanced enough where it can no longer, justifiably or economically manufacture lower value added things like inexpensive toys, shoes, clothing. We’re already seeing China lose business to other countries in that area. As long as China can transition to more high end manufacturing, I continue doing so. I actually think it’s happy to give up this business.

Roman Dubczak: Okay thanks. Let me ask either Bipan or Luis, because we talk about deglobalization or, you know, reshoring from China, from Asia, the beneficiaries are commonly perceived to be Latin American countries. In the in the Americas context, do you think that’s priced into those economies yet or those currencies?

Luis Hurtdao: Well, in the case of Mexico, we have seen a lot of traction towards this topic over the last year. But I would point out that the data doesn’t support yet, that we have seen enough inflows into investments in the country. And similar to when Max mentioned, Mexico may have some appeal from a lower cost perspective for US or Mexican companies. But from the infrastructure point, they are lacking. They don’t have access to electricity. And aside from the northern part of Mexico, the southern part, or other parts of that country, lack the infrastructure to move goods quite efficiently. So, yes, we may see some marginal positive effects in terms of investment, but also remember that we also need the imports from other countries into Mexico, so that could diminish the positive impact into the Mexican peso going forward.

Roman Dubczak: Thanks, Luis. And just the final question and maybe Bipan, for you. So, the conversations we’re having here, globally, we seem to be in an easing cycle.

Bipan Rai: Mmhmm

Roman Dubczak: Obviously, inflation is not solved yet, but 2024 is shaping up to be one exciting year from that perspective. Any kind of takeaways for us in terms of what to watch out for on a more granular basis as we, kind of, work our way through the year?

Bipan Rai: Absolutely. I mean, it’s a year fraught with event risk, naturally. I mean, the big headline is going to be the US election. But, I mean, circling back to what we’ve heard from Max and Luis, I think one of the big takeaways for our investors is that, you know, the de-globalization theme is here to stay. It’s going to be slow drip. but also at the margin, it means that things are going to be accretive to inflation, unfortunately. And that’s a new reality that we have to deal with post-pandemic and certainly post the middle part of the last decade. And it also means that at the margin, we’re also expecting to see volatility creep a little bit higher as well. And that’s going to be something that a lot of people are going to need to understand as part of a new reality.

Roman Dubczak: Yeah, great. Well, thanks. Those are a great way to kind of close off today’s session. So Bipan, Luis, Max, thank you all for joining us today. It was a very engaging session. Obviously, we could go on for many, many, many more minutes, if not hours on the topic. But I want to just thank all of our clients for joining us here today, hopefully provided some value and some insights that can help you in terms of shaping your business strategies. And we’ll look forward to see you again soon. Thank you.