Itaú BBA - Skeptical About the Bull-Ride

Latam FI Strategy Monthly

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Skeptical About the Bull-Ride

April 17, 2015

Latam FX and rates rallied over a month’s time, powered by a better sentiment

For the full report, see enclosed file 

Highlights

  • Latam FX and rates rallied over a month’s time, powered by a better sentiment towards EM assets. The latter follows a soft-patch in U.S. activity (and employment) data, as well as recent Fed signals of gradualism and data-dependency (for both timing of liftoff and pace of hikes). The significant decline in Latam credit spreads also suggests that the risk-on mood may have prompted the market to see the bright side of idiosyncratic stories and risks.
  • The market continues to price in future U.S. rates at much lower levels than the Fed “dots” (and our own forecast). Amid uncertainty about the outlook for global financial conditions, we simulated the effects of different scenarios for U.S. rates and commodity prices on Latam FX. The analysis confirms the idea that the outlook for Latam currencies remains highly dependent on global financial conditions, predominantly dictated by U.S. yields. Our simulations put the BRL as a likely outperformer in dovish scenarios and the MXN as outperformer in hawkish scenarios. The COP looks poised to be an underperformer, especially in hawkish scenarios. But the recent recovery in oil costs is proving some support for the Colombian currency. Based on these simulations, we recently opened a trade recommendation to go long MXNCOP: entry at 167.60, target at 174.00, and stop at 163.50. Due to the oil rise, the position is underwater for the time being (and close to the stop).

  • In rates, with U.S. market rates surprising on the downside, we maintain a generally cautious approach, despite the ongoing rally. In the back end, we see little value in current pricing of most Latam markets, from a fundamental standpoint. But we recognize that the risks of further delays in the Fed’s liftoff may induce further carry-driven positioning and further yield compression in the region. In the short end, we see value in some trades based on our Latam monetary policy views:     

In Brazil, the recent BRL strengthening supports the case for the BCB to end the tightening cycle with a final 25bp hike. Although, the BCB communications have not signaled a slower pace for now, economic activity remains weak, and downside risks are increasing for 2016. Thus, we recommend receiving Jan18 DI at 12.80% (target: 12.50%; stop: 13.00%). We maintain our long in NTN-B 2018, which has provided low-risk carry gains. 

In Mexico, amid a tepid economy and soft inflation, we expect Banxico to unpeg its policy decisions to the Fed at some point. Moreover, a slower-than-expected post-winter recovery in the U.S. might further delay the liftoff (both in U.S. and Mexico). We suggest receiving the 1-year at 3.72% and paying the 10-year at 5.88% (DV01 neutral), as our forward analysis suggests little additional downside for long TIIE rates. Our target is a spread of 235bps (currently at 213bps; stop at 200bps). 

In Colombia, as the market still prices in rate cuts (not our baseline anymore) we pay 1-year IBR swaps (entry: 4.39%, target: 4.70%; stop: 4.25%). We also open a IBR receiver call at the 10-year (entry: 5.97%, target: 5.80%, stop: 6.10%) to hedge our 5-year payer (now with a negative PNL).  

In Chile, the front end of Camara swaps is pricing in rate hikes nearly in line with consensus. Although we project no rate moves until end-2016, the hawkish tone from recent BCCh communications suggest that upside inflation surprises may prompt a move. We are neutral in Chile.


 

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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