Summary

We have highlighted emerging political risks across Latin America for some time, most notably in Chile and Peru. Over the last month, we felt as if conditions in Peru were improving as newly elected President Pedro Castillo dialed back rhetoric on his unorthodox policy agenda. However, in a dramatic turn, Castillo recently shifted back toward the populist-style platform that won him the Presidency, in-turn spooking local financial markets. While still too early to make adjustments to our Peruvian sol forecasts, political risk in Peru is still prevalent and risks around our USD/PEN exchange rate forecast are heavily tilted to the downside.

Renewed Political Risk Weighs on Peru

Throughout the entire COVID crisis, we have highlighted how a consequence of such sharp economic contractions could be a shift toward more populist-style policymaking, especially within the emerging markets. Up until now, Latin America is where this theme has played out the most with countries such as Chile and Peru already showing support toward candidates with socialist political ideologies, while Colombia and Brazil may be next as each country hosts presidential elections next year. We have publicized our concerns regarding the state of Latin American politics in a report earlier this year as well as voiced our worries in our Mid-Year Outlook. At a high level, a shift to populist political frameworks in these countries would likely place public finances on worsening trajectories, raise regulatory and expropriation risks, and could act as an impediment to foreign direct investment or multi-national corporations wanting to operate in each country. These risks have somewhat materialized in Chile amid the constitutional rewrite process; however, the election of the self-proclaimed Marxist Pedro Castillo as President of Peru has culminated in the manifestation of these concerns much quicker.

Castillo, a school teacher and former union leader, has a relatively radical political agenda. His platform focuses on significantly increasing social spending, redistributing wealth, higher tax rates, limiting the independence and decision-making abilities of Peru's institutions, and possibly nationalizing the country's copper mines and other natural resources. However, after a contested election, Castillo tried to walk back some of his platform and become a more moderate political figure. In that sense, Castillo tried to align himself with more centrist party members and calm financial markets by insisting he would respect Peru's constitution as well as the assets of foreign companies operating in the country. Early indications seemed to suggest Castillo was following through on these promises as he retained the head of the central bank, a well known and respected technocratic monetary policymaker, and appointed a former World Bank economist as his chief economic advisor.

On July 28, Castillo was formally inaugurated as President; however, his inauguration speech seemed to suggest a turn back toward the populist agenda that swept him into office, rather than the moderate promises made after being declared winner of the election. During his speech, Castillo suggested a referendum vote on the nation's constitution and that Peru needed to recover sovereignty over its natural resources. In addition, Castillo appointed left-leaning, also self-proclaimed Marxist political figures, to key cabinet roles such as foreign affairs minister as well as prime minister. And finally, and maybe most notably, Castillo failed to name a finance minister, which in our view, suggests his orthodox and technocratic chief economic advisor will probably not get the job.

The reaction to the shift in rhetoric has been swift and caught market participants, including us, by surprise. Ahead of the inauguration, we felt as if Castillo would in fact be a more moderate president and that political risk in Peru was receding, especially given the Peruvian Congress is heavily fragmented and most of Castillo's policy agenda would likely not be implemented. In our most recent International Economic Outlook, we adjusted our USD/PEN exchange rate forecast to reflect perceived reduced political risk associated with a Castillo administration. However, following a few days of local markets being closed, the sol opened significantly lower selling off over 3% and breaking through the key PEN4.00 technical level to reach a record low against the U.S. dollar (Figure 1). The USD/PEN exchange rate has also continued to diverge from copper prices, historically a reliable indicator to determine the direction of the currency, which in our view reflects the renewed political risk hovering over the country. (Figure 2).

Figure 1

Source: Bloomberg LP and Wells Fargo Securities

Figure 2

Source: Bloomberg LP and Wells Fargo Securities

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For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. 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