Summary of IR & FX Strategy Weekly: LATAM Sniper - 03 September 2013
Core Content
This document provides a comprehensive market analysis and strategic recommendations for the Latin American (LATAM) region, focusing on FX and interest rate (IR) strategies. The key themes revolve around the Brazilian Real (BRL) and Mexican Peso (MXN), with an emphasis on the impact of FX interventions, inflation expectations, and the outlook for the currency and economic fundamentals.
Main Views and Key Information
Market Outlook
- Brazil: The extraordinary USD auctions and FX program by the Central Bank of Brazil (BCB) are expected to keep volatility high, despite the intention to stabilize the currency. The BRL is expected to continue depreciating due to underlying macroeconomic issues.
- Mexico: The MXN has underperformed due to disappointing economic activity figures and the energy sector reform bill. The BCB's bolder FX interventions have also contributed to the BRL's strength, which led to the stop-loss on the short BRLMXN position.
- Interest Rates: The BCB raised rates by 50bp in line with expectations, but the statement was generic, suggesting no immediate acceleration in rate hikes. The market is closely watching the minutes from the MPC meeting for further guidance.
Strategic Positions
- Long USDBRL via options: The strategy team is taking advantage of the higher volatility environment to go long USDBRL using two different option structures:
- Seagull Call (2.385/2.515/2.270) with 1x1.5x1 ratios – zero cost structure, with spot reference at 2.360.
- 2m USDBRL 2.38 Call KO (2.51) – 35bp cost, with spot reference at 2.360.
- Steepener on PRExDI curve: The team remains comfortable with a steepener on the Jan'15 x Jan'17 PRExDI curve, as the curve is pricing in excessive rate hikes for 2014, and fiscal policy has not delivered positive surprises.
FX Intervention and Implications
- The BCB's FX interventions, including currency swaps and repo operations, have not significantly altered the fundamental trajectory of the BRL.
- The team emphasizes the importance of total FX exposure rather than just international reserves. The concept of effective FX reserves is introduced, which includes both spot and derivative operations, as well as external debt.
- The RPPP model suggests that the BRL should trade around 2.42 in the long term, but the current level is not considered an overshooting area.
- The team forecasts that the BRL will reach 2.75 by Q3 2014, driven by pre-election uncertainty and the deteriorating economic outlook.
Fiscal and Economic Outlook
- Current Account Deficit: For 2013, the current account deficit is expected to be USD 83bn, and for 2014, it has been revised down to USD 68bn.
- Trade Balance: The trade balance is expected to improve to a small surplus of USD 5bn in 2014, up from a deficit of USD 6bn.
- Fiscal Constraints: The lack of fiscal tightening and the government's fear of recession ahead of the 2014 presidential elections will likely keep the BRL weak.
- Credit Market: The CDS market has already priced in a potential sovereign downgrade, with the Brazilian minus Mexican 5y CDS showing a full downgrade.
FX and IR Recommendations
| Strategy |
DV01/Notional |
Entry Level |
Target |
Stop |
P/L |
| Long 2m USDBRL Call Seagull 2.385/2.515/2.270 (1x1.5x1 ratios) |
USD 10mn |
0bp |
- |
- |
- |
| Long 2m USDBRL 2.38 Call KO (2.51) |
USD 10mn |
35bp |
- |
- |
- |
Trade Review
| Trade |
PV01/Notional |
Entry Date |
Entry Level |
Current |
Target |
Stop |
P/L |
| Pay Jan'15xJan'17 PRExDI |
10k USD |
27-Aug-13 |
+118 bp |
+131 bp |
+170 bp |
+95 bp |
+14 bp |
| Stopped out Short BRLMXN |
USD 10mn |
6-Aug-13 |
5.515 |
5.650 |
5.200 |
5.650 |
-2.7% |
| Steepener 2s5s CDS in Venezuela |
5k USD |
13-Feb-13 |
+65 bp |
+108 bp |
+200 bp |
+35 bp |
+21 bp |
Performance Overview
| Year |
Interest Rates |
IR Options |
Bonds |
FX |
FX Options |
Credit |
| 2013 |
+5 bp |
- |
+98 bp |
3.0% |
7.4% |
+33 bp |
| 2012 |
+396 bp |
+77 bp |
+95 bp |
9.3% |
-1.0% |
-57 bp |
| 2011 |
+98 bp |
- |
+170 bp |
8.5% |
5.5% |
- |
FX and IR Forecast
| Quarter |
USDBRL Forecast |
| Q3'13 |
2.40 |
| Q4'13 |
2.45 |
| Q1'14 |
2.50 |
| Q2'14 |
2.55 |
| Q3'14 |
2.75 |
| Q4'14 |
2.60 |
Key Charts and Data
- Chart 1: President Dilma's popularity has dropped significantly, impacting fiscal and political stability.
- Chart 2: Inflation expectations are unanchored, signaling a loss of credibility in monetary policy.
- Chart 3: RPPP model for USDBRL.
- Chart 4: 2013 trade balance forecast.
- Chart 5: Brazilian current account vs. real FX rate.
- Chart 6: Effective FX reserves and external debt.
- Chart 7: Relationship between FX exposure and sovereign ratings.
- Chart 8: Brazilian minus Mexican 5y CDS.
Supply Calendar
| Date |
Country |
Issue |
Size/Details |
| 09/04 |
Colombia |
TES UVR 4.25% May-17 - Inflation-Indexed Bond |
- |
| 09/04 |
Colombia |
TES UVR 3.50% Mar-21 - Inflation-Indexed Bond |
- |
| 09/04 |
Colombia |
TES UVR 3.00% Mar-33 - Inflation-Indexed Bond |
- |
| 09/05 |
Brazil |
LTN (Apr-14, Jul-15, Jan-17) - Fixed Rate Bill |
- |
| 09/05 |
Brazil |
NTN-F (Jan-19, Jan-23) - Fixed Rate Note |
- |
| 09/10 |
Brazil |
NTN-B (Aug-18, Aug-22, Aug-30, Aug-40, Aug-50) - Inflation-Indexed Note |
- |
| 09/10 |
Mexico |
Cetes (28D, 91D, 182D) - T-Bill |
MXN 28.0bn |
| 09/10 |
Mexico |
Udibonos 2.0% 10y (Jun-22) - Inflation-Indexed Bond |
UDI 750mn (MXN 4bn) |
| 09/11 |
Colombia |
TES B 7.25% Jun-16 - Fixed Rate Bond |
- |
| 09/11 |
Colombia |
TES B 5.0% Nov-18 - Fixed Rate Bond |
- |
| 09/11 |
Colombia |
TES B 7.0% May-22 - Fixed Rate Bond |
- |
| 09/11 |
Colombia |
TES B 6.0% Apr-28 - Fixed Rate Bond |
- |
| 09/12 |
Brazil |
LTN (Oct-14, Jul-15, Jan-17) - Fixed Rate Bill |
- |
| 09/12 |
Brazil |
LFT (Mar-19) - Floating Rate Note |
- |
Important Disclosures
- This document is non-objective research and not independent investment research.
- It is a marketing communication and may be subject to conflicts of interest.
- BNP Paribas may have financial interests in the issuers or entities mentioned and may have acted on the information before its publication.
- The report is for professional clients only and not for retail clients.
- It is not intended to be relied upon as an authoritative source and is subject to change without notice.