The market is assigning a 79% chance to the Fed cutting rates, Wednesday, by 25 basis points, and a 21% chance of 50 basis points.
How will a fed rate cut affect the USD/Peso exchange rate?
An interest rate is of vital importance to real estate investors, such as myself, who've purchased a property in Colombia specifically to take advantage of the weak Colombian peso. See chart.
Theoretically, if the Fed cuts rates it should weaken the dollar. That said, they're almost an infinite number of cross-currents that affect currency cross rates.
At any other time, if you asked me what's likely to happen over the next 2 years, if the Fed goes on a loosening cycle, I'd say peso goes up.
But now I'm not so sure…
Why? Inflation and Keynesian economics being the overwhelming belief system of central bankers worldwide.
Let me explain, Keynesians believe that a weaker currency actually stimulates the economy because it makes exporting your goods and services cheaper, giving you a competitive advantage.
This is correct but it doesn't take the whole picture into consideration because the flip side of the coin is it makes imports more expensive, decreases innovation, and creates malinvestment.
Regardless we need to see things through the lens of the policymakers, not what's right or wrong.
We know policymakers like a weaker currency so why don't they constantly weaken it?
Because inflation, cost of goods and services, get out of control.
But a perfect scenario for the Keynesians is low inflation and cheap currency.
This is what could play out in Colombia.
Right now inflation is relatively low in Colombia. See chart
Side note: If you ever wondered why Colombian notes are denominated in 1000's instead of 1's (5000 peso bill and not just a 5 peso bill), 40 years of 25% inflation will do that! (see 1956 – 1996)
Currently, the peso is 3250/1, very low relative to the last 20 years, but inflation is oddly low as well.
A Keynesian dream come true.
My point is, if the Fed starts a loosening cycle, starting this Wednesday, it'll start a currency war (each country trying to make their currency cheaper) and Colombia will be in the mix.
Colombian policymakers will want to keep the cheap peso and the only way to do that will be to lower Colombian rates. Remember, low inflation gives them the green light.
If inflation remains low in Colombia, and the Fed starts lowering rates, look for the Colombian central bank to also lower rates adding to the probability of peso going lower against the dollar over the near term, 1 year.
Remember, all this is food for thought, I could give a very convincing argument for the peso going higher (low dollar pushes oil prices up. Oil up = peso up).
The main takeaway needs to be: pay attention to the macro, for us real estate investors it matters…a lot.
George