Brazil's real leads Latam FX losses on fiscal concerns

Brazil's real led losses across Latin American currencies on Tuesday on concerns over lower-than-expected inflation and stretched fiscal spending, while Chile's peso rose tracking higher copper prices.

The real fell 0.7% as monthly inflation slowed in January on a sharp fall in electricity prices, which led to some scaling back of near-term expectations for an interest rate hike.

But the annual rate of inflation remained high and well above the central bank's year-end target, indicating that a rate hike at the bank's next meeting was possible.

Approval of more local stimulus is also expected to increase inflation and spur rate hikes. President Jair Bolsonaro confirmed Latin America's largest economy was preparing a fresh round of cash transfers to millions of vulnerable people.

But investors were concerned that the increased spending could result in the government breaching its spending cap, pushing up market-based interest rates and pushing down the currency.

The country had posted a record deficit in 2020 due to the COVID-19 pandemic, and is struggling to rein in infections.

"The Brazilian central bank recently prepared the markets for an imminent rate hike. The only question is how quickly such a step would be taken," analysts at Commerzbank wrote in a note.

"Moreover, the question about additional fiscal policy measures to support the stricken economy is likely to remain an issue. Against this background we see little scope for BRL appreciation for now, even if the central bank were to initiate a rate hike cycle soon."

Brazil stocks were flat in early trade, while the MSCI's index of Latam stocks dropped more than 1%, as they continued to lag their emerging market peers this year.

Latam assets had lagged their broader peers in 2020 as well, owing to relatively higher COVID-19 spreads and concerns over economic health, given that several regional economies were facing headwinds even before the outbreak.

Chile's peso rose 0.2%, extending gains to a second day as copper prices rose on expectations of increased demand through the release of more global stimulus.

Chilean stocks also rose slightly.

Mexico's peso edged higher after annual inflation rose faster than expected in January. The reading raised expectations that the country's central bank would hold rates at its meeting later in the week.