Itaú BBA - On the Sidelines, With a View to Sell

Latam FI Strategy Monthly

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On the Sidelines, With a View to Sell

September 18, 2015

In Brazilian rates, we recommend an underweight position, in search for entry points to re-load steepeners and payers.

For the full report, see enclosed file 

Highlights

  • Since our last report, Latam FX has been volatile, tracking a zigzagging pattern in risk appetite and commodity prices. Latam rates have continued to underperform, however, owing to aftershocks from previous FX depreciation. Concerns about China and EMs and the path of U.S. rates will continue to be major external drivers for Latam assets.

  • Although the recent FX depreciation in Latam is justified by fundamentals, amid USD strengthening and falling commodities, our models suggest that some currencies could have performed better over the month, judging from the sole effect of (short-term) financial fundamentals (e.g., commodities, CDS, rates). Yet we do not take this “cheapening” in Latam FX (vis-à-vis fair values) as a “green light” for long positions, even for most resilient pairs (MXN, CLP). Despite a temporary post-FOMC risk-on expected for the coming days (maybe weeks), we continue to see chances of further disappointment in China and a Fed liftoff in December. These events may have negative effects on Latam assets.  

  • Latam local rates temporarily decoupled from U.S. Treasuries, amid a widespread sell-off locally. These pressures reflect a hawkish tone by central banks in the region, following the FX weakness and slight gains in inflation expectations. Our fair-value analysis suggests remaining upside for rates on the belly and back end in some markets (e.g., Chile and Mexico). The front end looks well priced in most cases. For now, we stay on the sidelines amid an improved risk appetite following the dovish FOMC outcome. But we believe this rally will be temporary and we wait for a better timing to re-build payers and steepeners.  
  • In Brazil, a deteriorating fiscal outlook (reason for the recent sovereign rating downgrade to “high yield” by S&P) is the main factor behind the BRL underperformance and the re-steepening of the yield curve. Despite recent initiatives to bridge the gap for budget 2016, we see high implementation risks. Albeit comparing asset-implied projections with analysts’ forecast surveys would suggest a hefty premium, economic and political difficulties remain consistent with a brisk rise in government debt in coming years, and heightened inflationary jitters. In all, these idiosyncratic risks may continue to weigh on FX and rates, in spite of a (potential, but temporary) global rally.   
  • As per our recommendations:

In Brazilian rates, we recommend an underweight position, in search for entry points to re-load steepeners and payers, especially on the back end.  

We keep our TIIE 5-year payer in Mexico. Our entry was at 5.53% (currently: 5.45%). The trade took a hit after the FOMC meeting. Our target is 6.00% (stop: 5.20%). We see upside for long Mexican rates. 

In Chile, we took profits on our payer at 10-year Camara swaps:  we entered at 4.58% and left at 4.75% (gain of 142bps). We still see upside for the back end of Chilean curve, and will seek to re-enter.     

In Colombian, the recent bear-steepening took long yields close to our fair value. On the front end, the market prices in more hikes than analysts. Yet we refrain from receiving, given our macro projection of upcoming rate hikes. We are on the sidelines for now. 

In FX, we take half-heartedly the signs of “cheapness” flagged by our fair-value models. For now, we wait for better tactical moments to sell currencies, especially the most sensitive ones (BRL, COP). 


 

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