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Latin America Weekly Strategy Summary - Week of 09-13 June, 2014

Core Content

This report provides a strategic analysis of Latin America's financial markets, focusing on currency, interest rates, and bond flows. It outlines the current market conditions, key factors influencing the region, and tactical recommendations based on market dynamics and economic scenarios.

Main Hypotheses and Scenarios

• China's Rebalancing Policy: China is focusing on cleaning up its shadow banking system, which is beneficial for long-term development but a concern for commodity-oriented emerging market (EM) economies in the short to medium term.
• US Economic Growth: The US economy is accelerating with subdued inflation. The Federal Reserve is not expected to trigger a hard landing.
• ECB Policy: The ECB is supportive, but its impact is less significant than US quantitative easing (QE) and operation twist.
• EM Convergence: The EM to US Treasury (UST) and high yield (HY) convergence is expected to stabilize at current levels. Further improvement would require UST10y yield to remain around 2.35-2.45% for an extended period.
• Risk Premium: The global risk premium is at a neutral level, with a dichotomy between different asset classes. The market is not in a structural break but in a phase of tactical adjustments.

Key Market Dynamics

• Latin America (Latam): The region is expected to stabilize, with small corrections rather than a significant sell-off. Mexico and Chile are the exceptions with more pronounced linkages.
• UST Yield Impact: UST volatility and yield movements are key drivers of EM and Latam fixed income flows.
• FX Flows: Portfolio flows into EM fixed income have increased significantly, with Latin America receiving flows equivalent to the 99th percentile.
• Institutional Flows: Since March 2014, institutional investors (excluding ETFs) have poured over $1.03bn into Latam bond funds and $1.72bn into equity and bond funds combined.

Tactical Positions

Interest Rate (IR) Strategy

Open Recommendations

• Brazil: Pay DI Jan-18 and receive DI Jan-16 to exploit the flat belly of the swap curve.
• Brazil: Target DI Jan-21 at 12.25%.
• Brazil: Short USDBRL for 3 months.
• Mexico: Long 2y break-even inflation and June 2016 Udi-bonos; pay 2y TIIE at 3.69%.
• Colombia: Receive 18m IBR rates at 4.65%; target 4.37%.
• Chile: Short USDCLP and NZDCLP at 562 and 478.50 respectively; pay 5y Swap CLPxCAM at 4.24%; target 4.58%.

Closed Recommendations (YTD)

Performance Summary

• Total Trades: 13
• Positive Trades: 10
• Negative Trades: 3
• FX Trades: 3 (2 wins, 1 loss)
• Rates Trades: 9 (8 wins, 1 loss)
• Bond Trades: 1 (1 win, 0 loss)
• Average Return per Trade: +37bps
• Average Return per Positive Trade: +70bps
• Average Return per Negative Trade: -68bps

Market Flows and Dynamics

• Emerging Markets (EM): Total bond and equity flows have increased significantly, with fixed income and equity flows reaching record highs.
• Latin America (Latam): Bond flows have reached the 99th percentile, showing a strong inflow trend.
• Brazil: Portfolio flows from foreigners into fixed income assets reached $5.7bn in March and $3.7bn in April, with cumulative flows of $15.35bn since 2014.
• Mexico: Institutional flows into bond and equity funds reached $1.03bn since March 2014, with a total of $1.72bn into both categories.
• UST Yield Impact: The back end of the local swap curve has increased due to UST yield movements and domestic monetary policy.

Economic Surprise Model

• The model indicates that economic surprises are hovering around neutrality, with mixed signals.
• Key indicators include GDP, industrial production, and consumer confidence, with varying weights and model values.
• Negative inflation surprises are reflected with negative model values.

Global Risk Premium Model

• The global risk premium is at a neutral level, with a dichotomy between different asset classes.
• The model suggests that the market is not in a structural break but in a phase of tactical adjustments.
• The risk-taking scenario is not a structural shift but a temporary tactical stance.

Conclusion

• Improvement: The market is showing improvement, but it remains neutral.
• UST is Key: UST yield movements are crucial for EM and Latam markets.
• Convergence: EM rates are converging towards US Corporate HY, but the convergence is expected to stabilize.
• Diversified Strategy: The strategy involves a mix of tactical trades in FX and IR, with a focus on short-term gains.
• Liquidity and Risk: Global liquidity is supportive, and the risk premium is at a neutral level.
• Economic Outlook: Economic activity and surprises are mixed, with some positive trends but overall neutrality.

This summary outlines the strategic outlook, key market dynamics, and tactical positions for Latin America in the week of June 9-13, 2014, emphasizing the importance of UST yield and the need for a diversified, tactical approach.