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Latin America Weekly Strategy Summary - Week of 02-06 June, 2014

Core Content

This document outlines the Latin America weekly strategy for the week of 02-06 June 2014, focusing on the impact of global economic conditions, regional economic dynamics, and specific market instruments on investment strategies.

Main Topics and Views

1. Flow Analysis

• Emerging Markets (EM) and Latin America (Latam) have seen a shift in investment flows, with a rotation from EM to Developed Markets (DM) continuing.
• The market is currently in a neutral to bullish stance, with UST (U.S. Treasury) yields being a key driver.
• Hedge funds and foreign portfolio investment have been instrumental in shaping the local swap curve, especially the back end.

2. Global Risk Premium

• The Global Risk Premium model suggests a neutral to risk-taking approach, with data dependence dynamics still in play.

3. EM Convergence to UST Corporate HY

• The convergence of EM rates to UST Corporate High Yield (HY) is expected to stabilize at current levels.
• A significant improvement in EM rates is only possible if UST10y yield remains around 2.50-2.60% for an extended period.

4. Economic Surprise Model

• The model indicates that the Latin American market is hovering around neutrality, with economic surprises playing a crucial role.
• Key indicators include GDP, CPI, retail sales, and industrial production across Brazil, Mexico, and other countries.

5. Brazil Strategy

• DI (Direct Investment) strategies are recommended, with a focus on tactical steepening and over-shooting levels.
• BRL (Brazil Real) is considered to be at over-extended levels, with a target for DI Jan-21 at 12.35%.
• Brazil swap curve is analyzed, with a flat belly indicating potential for tactical adjustments.

6. Brazil Domestic Rates Scenarios

• The DI Jan-18 and DI Jan-16 rates are suggested for a pay-receive strategy.
• The BRL swap curve is expected to continue its dynamics, influenced by UST yield and domestic monetary policy.

7. El Niño Impact

• A 70% probability of an El Niño event in IIIQ2014 is noted.
• El Niño is expected to have a positive impact on agricultural prices and equity markets, particularly in Argentina and Brazil.
• The market has not fully priced in the implications of El Niño on FX dynamics and risk assets.

8. Mexico Peso Analysis

• The Mexican Peso (MXN) is in a tactical short position.
• Institutional investors ex-ETF have shown a positive trend in bond flows since March 2014.

9. TIIE Strategy

• TIIE (Turkish Lira Index Exchange) rates are monitored, with a focus on tactical positioning based on UST yield and global macro trends.

10. World Economic Landscape for Latam

• The global economic environment continues to influence Latam markets, with a neutral stance expected unless UST yield shows significant volatility.

Key Recommendations

Open Recommendations

• Short USDCLP and NZDCLP
• Pay 5y Swap CLPxCAM at 4.24%, targeting 4.58%
• DI Jan-21 at 12.03%, targeting 12.35%
• Receive 18m IBR Rates in Colombia at 4.65%, targeting 4.37%

Closed Recommendations (YTD)

• Brazil DI strategy with tactical rates steepening and fly strategies have been executed.
• USDCLP and BRLCLP trades have been closed with positive returns.
• Chile Swap CLPxCAM and Colombia bond strategy have been closed based on model-driven decisions.

Changes in Flows

• Equity flows in Brazil have become more evident, with $1.93bn in inflows since end of March.
• Institutional investors ex-ETF have poured $989m into bond funds since March.
• The combination of equity and bond flows has reached +$1.718bn since March 2014.
• The UST yield has had a considerable impact on EM local rates, with a 63bps drop since December 2013.

Analysis of the Swap Curve and Rates

• The Brazilian swap curve is too flat in the belly, indicating potential for tactical adjustments.
• The back end of the local curve has been up by +300bps, linked to UST dynamics and domestic monetary policy.
• The DI Jan-21 is over-extended to model fair value, with a target of 12.35%.

Impact of UST Yields on EM

• UST yield has a strong impact on EM local rates and sovereigns.
• Corporate HY spreads over UST have improved due to positive effects on activity and cost of capital.
• UST10y yield has dropped by 27bps since December, affecting EM local rates.

El Niño Scenario

• El Niño is expected to have a positive impact on agricultural prices and equity markets.
• EMBIG Index is projected to gain 9% before and 16% after El Niño begins.
• Agricultural prices (SPGSAG Index) are expected to increase by 20.2-24.4%, with BRL gaining 5-10.1%.

Economic Surprise Model

• The model uses economic indicators to assess market sentiment.
• Inflation surprises to the upside have a negative sign in the consolidated value.
• Key indicators include GDP, CPI, retail sales, and industrial production.

Conclusion

• The UST scenario of 2013 has not repeated, with a -58bps movement.
• Liquidity is not shrinking, and rotation from EM to DM has stopped.
• Search for yield is a direct function of UST and Corporate HY performance.
• EMBIG is expected to converge to US Corporate HY, but spreads may not tighten significantly due to UST dynamics.

Summary of Key Indicators

Notes

• UST volatility and monetary policy in Japan and Europe are key exogenous factors.
• Search for yield is a direct function of UST and Corporate HY performance.
• El Niño is expected to have a positive impact on agricultural prices and equity markets.
• Inflation dynamics may be misleading, with CPI not showing significant spikes.
• Model-driven strategies are recommended due to the initial stages of normalization in premium/cost of capital.