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How to understand peso-dólar behavior in last weeks

OCH Blog diferencia entre el peso y el dólar

Este contenido es producido por OCH Group, Independent Member de GGI en Colombia.

How the US interest rate differential has behaved and how it has affected the exchange rate in recent weeks and its impact on the investment environment. We will talk about that in the next blog.

The Colombian peso and the rate differential with the United States

 

  • The rate differential between Colombia and the United States has made Colombian peso attractive to investors over last year.
  • The stability in the exchange rate in recent weeks makes investing in the Colombian currency even more interesting as it offers high rates in a context of low volatility.
  • In short term, we expect colombian peso to remain stable and appreciate towards $3,800 during first half of this year, assuming that U.S. economy continues its soft landing process.
  • During the second half of the year, Colombian peso will be less attractive, as local interest rates are declining and Colombia risk premium remains relatively high as a result of uncertainty on the fiscal front. We expect an exchange rate close to $4,200 during the second half of 2024, although we project a year-end closing at levels of $4,085.

The exchange rate has been parked in recent weeks at levels close to $3,920 pesos per dollar. Much of deviation of peso against its regional peers during colombian election period and the second half of 2022 has been corrected. Colombian peso is now at levels similar to those of other currencies in the region, which suggests that going forward the dynamics of our currency will depend on what happens with dollar in the international financial market.

On external front, fate of dollar will depend on monetary policy of US Federal Reserve and US economy’s ability to avoid a recession. Everything points to a soft landing for the U.S. economy, with inflation gradually declining, which would allow Fed to start a rate-cutting cycle in June without a shock to economic activity. This soft landing, which would be possible thanks to increase in productivity and a resilient labor market, generates a favorable context for currencies of emerging countries such as Colombia.

Colombian peso, having overcome sudden devaluation of 2022, has been favored by the rate differential between Colombia and United States. The current differential is 7.25%, if we take the reference rates of monetary policy and the Fed. A wide differential makes our currency attractive to the extent that it allows investors to take advantage of a wide return once they invest in local fixed income instruments, or more simply take purchase positions in the peso through the forward market. This strategy is known as Carry Trade.

Let us remember that the devaluation rates of the peso-dollar forward market are a reflection of the interest rate differential between Colombia and United States. In recent months we have seen a wide interest rate differential, which coincided with the appreciation of the Colombian peso. In recent months we have had a relatively stable level in the peso. A less volatile exchange rate makes the Carry Trade even more attractive. Investors compare different currencies on their ability to generate higher returns adjusted for the implied volatility in forward options (Carry-to-Vol). In that respect, the Colombian peso is attractive, even under the expected path of interest rate cuts.

However, if Banco de la República surprises the markets with larger rate cuts, such as a 100 basis point cut at one of its upcoming meetings, this could reduce the rate differential and, therefore, the attractiveness of colombian currency.

The reduction in the current account deficit, the rate differential with United States, and the eventual start of the rate cutting cycle by Fed, would support a peso that could strengthen towards $3,800 level in remainder of first half of this year.

However, regulatory and reform uncertainty, coupled with growing fiscal concerns, would prevent further appreciation and could contribute to a devaluation of the peso in the second half of 2024. This, coupled with a gradual reduction in rates, once rate cuts by the Central Bank accumulate, should drive the peso back to levels near and above $4,000 in the second half of 2024.

 

Source:

  • Capital Inteligente, Bancolombia, april 2024

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