Itaú BBA - Waiting for the Liftoff

Latam FI Strategy Monthly

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Waiting for the Liftoff

July 22, 2015

The expected process of monetary policy normalization in the U.S. will add pressure on Latam FX and yields ahead.

For the full report, see enclosed file 

Highlights

  • Amid continued USD strengthening, Latam currencies weakened more than EM-peers over a month’s time. The decline in commodity prices, the more uncertain global environment, the widening in CDS spreads and the increase in U.S. market rates (front end) were the main factors behind the underperformance in Latam FX.
  • Latam local rates moved down over a month, generally speaking. A notable rally took place on the belly of Brazilian curve and on back end of Chilean yield structure. The recent action in Latam rates seems driven by persistent signs of weak growth (e.g., intensifying recession in Brazil, soft recovery in Chile).

  • Looking ahead, the (expectation for the) rate normalization process in the U.S. continues to play a key role in Latam FX and yields. While we look for a December liftoff, we believe that the market could price in greater chances for a sooner (i.e., September) move by the FOMC. Fed Funds futures already factor in one rate hike this year, but the yield curve continues to lag the committee’s forward guidance. So, pressures (on FX, yields) may follow the liftoff, and it is natural to expect spillovers into Latam markets.
  • Amid uncertainty about the U.S. liftoff timing and speed of USD appreciation (the latter could take a breather in coming days, following this recent rally), we continue to prefer relative trades within the realm of Latam FX. We like long/shorts using the less sensitive currencies in the region (CLP, MXN) on the buying leg against less resilient pairs (BRL, COP) on the selling side. These trades explore the different stages of external sector adjustment in some of the main Latam economies.
  • We still see Latam rates fairly priced on the front end of the yield curves. However, we see upside for long rates in all markets under our coverage, as the current pricing for terminal rates stands short of our fair-value assessment. As the U.S. rate normalization kicks in, we see good opportunities for payers. In Brazil, the political risks (and weak activity) are delaying the implementation of budget-fixing measures and denting the fiscal outlook: that could add pressure for long rates ahead.
  • As per our trades, we keep most of the recommendations seen in our last report:  

In Brazil, we took profits on our Jan25 x Jan16 steepener before the market intensified a rally in long yields, following increased expectations of rate convergence (with an easing cycle about to start in 2016). 

Amid increased execution risk on Brazil’s fiscal adjustment process, and despite the persistent CLP weakness, we maintain our recommendation to go long CLP and short BRL. We entered with the BRL/CLP cross at 206.77. But our target was revised to 198 (stop: 210). 

We maintain our steepeners in Mexican TIIE IRS, receiving the 1-year and paying the 10-year, DV01-neutral. We entered with the spread at 266bps (now: 259bps), and our target is 315bps (stop at 245bps).  

We keep our payer in 5-year IBR swap rate in Colombia. Entry was at 5.36% (now: 5.32%) and our target is 5.75% (stop at 5.00%). 

In Chile, although we remain neutral on rates for now, we see good opportunities paying the long segment of Camara swap rates (10- to 20-year) and we are looking for better entry points in coming weeks.


 

Open Recommendations 

Closed Recommendations


 


 



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