Given the sorry state of financial markets, it seems that being bearish is the new black. It is also analytically comfortable; if you claim things are going to get worse, people will rarely ask for details. It is however worth remembering that there are different species of bears. Unless we distinguish among adverse scenarios and understand what it takes for any of them to materialize, we are at the mercy of circumstances. We know that unbridled optimism is dangerous – think about financial bubbles – but seldom acknowledge the risks of its opposite, what I would call “irrational bearishness.”
Let´s revisit the basis for our current bearishness to try distinguishing fact from fiction.
2022 is indeed more challenging than what we thought. Leaving behind the COVID-19 shock has been successful in terms of activity levels, and accordingly, its side effect – inflation – has been more persistent. It also means that to a large extent global factors – rather than local ones – still determine performance. A map based on the IMF´s April World Economic Outlook projections shows only a handful of countries with inflation levels at 3% or below – none of them in the Americas.
Then we have the invasion of Ukraine by Russian forces. It is terrible news, but military conflicts can boost aggregate demand, so they are not necessarily recessive affairs. Moreover, the share of Ukraine and Russia in global trade and Gross Domestic Product suggest that the direct effect of the disruption is probably less than that the one associated to COVID-19 shutdowns in China, for instance. What about energy and soft-commodity markets, where the two countries involved in the conflict are relevant players? So far, physical disruptions have been rather modest, certainly less of what spot prices would suggest, therefore leading me to wonder to what extent we are seeing self-fulfilling expectations at play.
We can elaborate a bit more in this direction. For higher commodity prices to create recessionary risks, a country has to be a net importer of the stuff that is getting dearer. Then what takes place is a deterioration in that country´s terms of trade, which implies income transfers from the net importer to the net exporter. We know this effect very well in Latin America, as it is at the core of the Prebisch-Singer hypothesis.
In that regard, I cannot help but scratch my head every time I hear someone arguing that the U.S. will be back to the stagflationary scenario of the 1970s. Back then, the U.S. was a net oil importer and the ensuing deterioration of terms of trade transferred income to the Arab world. Currently the U.S. is not only a net oil exporter, also its energy intensity has declined at a rate of about 2% per year since 1973. If this is the bear that haunts you, it is of an European or the Japanese breed, not an American one. Which is consistent with what we have seen in the currency markets.
The real risk for the U.S. economy is of a self-inflicted nature. Namely, that the Fed is forced to slam on the brakes. Even though leverage among U.S. households is low, higher interest rates, along with a drop in giddy stock markets could lead to worsening financial conditions, via a wealth effect. If there is a recession in the U.S., it will be Fed-induced, and the question is how this risk compares with inflation concerns in the minds of policymakers.
Against this backdrop, what kind of wild bears roam in Latin America? Fed risks keeps regional policymakers awake at night, as they are on the look out for a new “taper tantrum” episode – similar to the one that took place in 2013. However, we should keep in mind that back then we were coming from being the “flavor of the day”, at least in terms of foreign inflows: the current account deficit stood at 2.8% of regional GDP vs. 1.5% in 2021 according to ECLAC figures. This is because during the recent episode of excess global liquidity Latin America was not at the receiving end of investors´ largesse: technology stocks, alternative assets and crypto for instance took that place.
Moreover, we are at the opposite side of the wealth transfer associated to commodities – our regional terms of trade have improved. Last but not least, inflation never became extinguished in our region, which means we were better prepared for its renewed assault. This helps to explain why regional central banks were the first in hiking.
On a comparative basis therefore, our regional scenario worsened less than those for other parts of the planet. This call for a peculiar form of bearishness, less of the macro-financial sort, more focused on growth and income distribution prospects. Unfortunately, I do not see any compelling narrative on the region on how we are going to address these critical issues. Rather, politicians remain reactive: think about Andres Manuel Lopez Obrador in Mexico pretending to introduce prices controls to tame inflation – playing whack-a-mole with prices only makes Banxico´s task more difficult. Then again, the crisis in political leadership is not exclusive to Latin America. Nowadays, this is perhaps the most extended breed of bear worldwide.