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Friday 7th June saw a very interesting macro development in Latin America. Not the Trump tweet suggesting that the US may, after all, be interested in continuing to conduct trade with its neighbours (the informational content of that move is close to zero), but rather the surprise policy interest rate cut in Chile.

On that day, the board of Banco Central de Chile (CBC) surprised markets with a 50 basis point cut in its policy interest rate. None of the 18 economists contributing to Bloomberg’s consensus forecast had predicted this move, and it was a sharp change from the CBC’s guidance earlier this year. As well as being a surprise, the cut was the biggest cut since the Global Financial Crisis by the CBC, a central bank with a reputation for steady, well-signalled moves.

The main reasons the CBC gave in its subsequent monetary policy statement were:

• CPI inflation, both headline and core, remaining around 2%
   
• Economic activity slowed in the first quarter, to less than expected levels, with primary industries and investment being particularly weak
   
• A recalibration of the CBC’s estimates of the potential for the Chilean economy in the light of recent immigration
   
• Trade tensions: ‘Abroad, the main development since the last Monetary Policy Report has been the escalating conflict between the United States and its main trading partners, resulting in increased risk aversion, affecting the value of assets, currencies and commodities, as well as Chile’s terms of trade.’

The recent economic data is what it is, although it is important not to be too negative: local currency bank loans outstanding in May rose 8.4% on a year earlier, and nominal wages rose 5.1% in the year to April. Clearly, the weakness in other data led the CBC to react at this time.

In addition, the CBC has come to realise that monetary policy was tighter than thought because the output gap was larger than previously thought. This is due to the positive impact of recent immigration on potential economic growth. Chile (population less than 20 million) has received about 700,000 migrants between since 2015, mostly from Venezuela and Haiti. The central bank has adjusted its estimates of the effects of this surge in immigration on growth, increasing estimated potential growth range by 25 basis points to 3.4% for 2019 to 2021, which in turn lowers the estimated neutral monetary policy rate down by 25 basis points. This kind of statistical adjustment is not unheard of in dynamic emerging economies like Chile.

However, for us the key is the third reason. To quote the CBC’s statement: 

‘Externally, the balance of risks continues to be biased downwards, making the occurrence of negative events more likely. The escalating trade conflict between China and the US has taken front row and has begun to permeate other areas of the relationship between the two economies. In addition, the US tariff decisions have spread to other countries and with motivations other than strictly commercial ones. All this has raised fears of a sharper trade slowdown, a deterioration in the confidence of companies and households globally and a loss of dynamism in global activity. Another concern is the resurgence of the possibility of a no-deal Brexit. Scenarios where these risks intensify could lead to a sharp deterioration of financial conditions, in which case the main central banks would probably make their monetary policies more expansionary. However, this may be insufficient to contain the loss of risk appetite and the fall in asset and commodity prices. The high prices that some riskier assets have reached —in some cases mirrored by increased borrowing— makes such a scenario much more complex. The materialization of any of these scenarios could have a negative impact on local investment decisions and expectations.’

Outlook and current portfolio positioning

For us, this is one of the best central banks in emerging markets putting down a marker of where we are headed: cyclical slowdown, higher risks and easier monetary policy. That may seem like a negative environment for emerging market equities, and we cannot get too excited about China, some of the China-facing Asian markets, or many commodity-exporting economies. But one of the great opportunities in EM is the diversity at the country level – one man’s meat is another man’s poison.

Accordingly, we have retained our underweight in China, have moved underweight Taiwan (but remain overweight South Korea, which we believe will be a net beneficiary of tariffs on its competitors), and remain overall cautious on Brazil, Peru, Colombia and Chile. 

On the other hand, a world of lower commodity prices and lower interest rates will be highly beneficial for some other emerging economies; we remain heavily overweight India, have begun building a position in Turkey, and note the positive implications of the new environment for other carry-trade/current account deficit markets, such as Pakistan and Indonesia. Russia and the UAE (both overweight positions) have the potential to benefit as well.

The CBC’s rate cut may have been a surprise relative to expectations, but the CBC is far from alone. India, Sri Lanka, Malaysia and the Philippines have all cut interest rates in recent weeks, as expectations for US monetary policy have moved sharply towards multiple rate cuts this year. The world’s savers need growth and they need yield. When the asset class doesn’t provide the former, it should provide the latter.