Tue. Dec 1st, 2020

With the federal reserve Chairman Jerome Powell has now raised little doubt that the Fed will continue raising interest rates in the coming year, with US policymakers considering the potential economic impact that these rate hikes will have on the economies of countries south of the border . It seems particularly the case that it is Brazil and Mexico, two of Latin America’s largest economies, that are likely to be most affected by high US interest rates in their presidential elections later this year.

Emerging market economies generally do well, with global liquidity being adequate and poor when the global liquidity position is strong. When global interest rates are as low as they have been in the past nine years, emerging market economies flow with money from abroad in search of higher yields. However, when global interest rates begin to rise, money is repatriated from emerging markets to the relative security of more advanced economies. Often, it is this capital repatriation that causes considerable distress to emerging market economies, especially if they were not prepared for a rainy day.

As Jerome Powell considered in his congressional testimony this week, there are good reasons to think that US interest rates are high enough in the period ahead to keep the economy from overheating. It is not just that the US economy is already or perhaps beyond full employment and growing at a rate above its long-term potential. Rather, it is that the American economy is now receiving considerable economic stimulus in times of cyclical strength. This is courtesy of abnormally adjusted financial conditions, bouncing equity prices and a weaker dollar, as well as Trump tax cuts and increased public spending.

Political cartoon on economy

The potential increase in US interest rates comes at a particularly inadequate time for Mexico. In July, that country is headed for a presidential election, which should be expected to increase domestic political uncertainty. This is particularly the case considering that leftist-leaning radical populist leader Andres Manuel L√≥pez Obardor is currently leading the election. The possibility that Mexico may shy away from market-based economic policies and take a more confrontational stance for its northern neighbor is hardly likely to instill confidence in foreigners, who currently account for about 40 of Mexico’s outstanding government debt Percentage share is estimated.

Another reason for accelerating the flow of capital out of Mexico is that the rise in US interest rates is uncertainty over NAFTA negotiations in the wake of the Mexican election. This is particularly the case, considering that the US accounts for about 70 percent of Mexico’s exports, and the election of a less viable Obrador as president for a favorable NAFTA deal or continued US involvement in that country. Will reduce opportunities for direct investment.

Brazil is perhaps even weaker than capital in response to rising US interest rates. This is not simply because the entire Brazilian political class has been tainted by the Petrobras scandal and because Brazil’s October elections are likely to produce a populist president from the left or right of the political spectrum. Rather, Brazil’s public finances are in disarray.

Currently with a budget deficit of around 9 percent of GDP, Brazil’s public debt is on a clear path. It should pose a real risk that investors can take flight Brazil’s elections should create an inability or inability to address the country’s public finances problem and defy the bomb at the time of its unnecessary pension system.

It is in the American interest to have political and economic stability in our backyard. The reason why one has to anticipate that American policy-makers are already thinking about how they can respond to the real economic and financial tensions in Brazil and Mexico is because the Fed is the only one with monetary policy going forward Increases. One should also expect that American policy makers will be supportive of IMF involvement in countries that become necessary.

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