Itaú BBA - Bracing for the Fed’s liftoff

Latam FI Strategy Monthly

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Bracing for the Fed’s liftoff

March 16, 2015

Fair value models confirm that BRL and COP are the most vulnerable pairs (to US rate hikes) in Latam

For the full report, see enclosed file 

Highlights

  • Lower commodity prices, weakening exchange rates, tighter credit conditions, idiosyncratic economic vulnerabilities, all seem to be weighing on Latam macro fundamentals and adding pressure on credit spreads (yet quite asymmetrically, country-wise). In general, the rise in Latam CDS premium mirrors the region’s dependency on external financing and commodity revenues (at least in comparison with other EMs). The limited room for countercyclical policies also adds to this picture.
  • Under these challenging macro conditions (external and domestically), Latam rates and currencies sold off, with both asset classes underperforming EM peers. Market sentiment worsened particularly in Brazil, with Colombian assets also under pressure.

  • In Latam FX, fair value model simulations confirm that BRL and COP are the most vulnerable currencies in the region, given the expected rise in US rates. The estimates are in line with structural challenges facing Brazil and Colombia on both fiscal policy and balance of payments. Our results suggest larger upside for USDBRL in the short run (i.e., in a few months) and for the USDCOP in the medium run (i.e., by yearend).  While MXN and CLP are poised to weaken against USD, we see relatively less downside for those, offering opportunity for (defensive) long/short trades.

  • In Latam rates, correlations with US Treasury yields, CDS spreads and FX have increased, and we believe this trend will continue in coming months. Given the large upside for US rates ahead, adding payers is the natural way to brace for the upcoming Fed’s liftoff (whose signals are expected for the March 18 FOMC meeting). Since monetary policy expectations seem well priced in the front end (except for Brazil), our recommended strategy is to position in the belly or in the long end.       
  • We summarize our trading ideas (or views) below:

In Brazil, we prefer to be on the sidelines amid elevated (macro and political) uncertainties, and huge market volatility. While external fundamentals broadly support a BRL re-pricing, the FX rate move has been unexpectedly front-loaded, considering our macro adjustment scenario. We also see excessive premium in rates, notably in the front end. Still, upcoming (domestic and external) events will probably give no opportunity for an entry.   

In Mexico, based on expectations of higher US rates, we recommend paying the 10-year TIIE swap (currently: 6.25%), with target of 6.60% (stop at 6.10%). Owing to diverging central bank policy stances, we also recommend going short EURMXN: enter around 16.35, with target at 15.80 (2.7% upside) and stop at 16.45 (1.3% downside).

In Colombia, we recommend paying 5-year IBR swap (currently at 5.35%), with target at 6.00% (stop at 5.00%). We are also short COP again: enter around 2,670/USD, with target at 2,800/USD (4.9% upside) and stop at 2,630 (1.5% downside) 

In Chile, we maintain our payer at 5-year sector in Camara swaps (currently at 4.14%), with target at 4.50% (stop: 3.80%)


 

Open Recommendations 

Closed Recommendations


MACRO TEAM:

Ilan Goldfajn - Chief Economist
Caio Megale
, caio.megale@itaubba.com
Mauricio Oreng, mauricio.oreng@itaubba.com

Luiz Gustavo Cherman, lcherman@itaubba.com
 



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