Itaú BBA - Banrep’s surprising rate cut caused gains to our receiver position

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Banrep’s surprising rate cut caused gains to our receiver position

November 10, 2017

We are received in the 18-month IBR swap; the trade is performing well so far and we expect it to improve further ahead.

STRATEGY TEAM:
 

Ciro Matuo, CNPI, ciro.matuo@itaubba.com
Eduardo Alonsoeduardo.marza@itaubba.com


For the full report, see enclosed file
 

Highligths

  • Banrep surprised the market by cutting the policy rate by 25bps to 5.0%, while the majority of the analysts expected the central bank to remain on hold until early-2018. We are received in the 18-month IBR swap since September (see Receive 18m IBR rates in Colombia as non-tradable inflation starts to fall - LatAm FI Trade Idea). The trade is performing well so far, registering a positive return of 33bps. We expect it to improve further ahead, since we project the easing cycle will end with a policy rate of 4.5%.
  • Brazil’s Copom communication suggests the plan is still to slow down the pace of easing moderately. We read this as a signal the December move will probably be a 50-bp cut. At the same time, the date to end the easing cycle was purposefully left wide open by the Brazilian monetary authority.
  • In particular, markets noted the absence from the statement of the sentence regarding BCB’s preference for a gradual end to the cycle. This implies some risk that the next 50-bp rate cut may be the last. The prices of options over the IDI index reveal this is indeed the market’s most likely scenario: the probability of one last 50-bp cut in December and an unchanged Selic in the February and March meetings is around 39%.
  • Option traders’ alternative scenario (27% odds) would be a 50-bp cut next month, followed by a last 25-bp cut in February. Meanwhile, put spreads are pricing only a 13% probability of two consecutive 50-bp cuts (coming on December and February).
  • On FX, Brazil’s solid external position has been containing hedging costs for the BRL. In fact, its risk-adjusted carry seems attractive vis-à-vis other high-yielders such as the ZAR, the TRY and the MXN - all of which are battered by idiosyncratic risks.

 



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