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Latam Strategy Monthly September 2014 Summary

Core Content

This document is a report from BNP Paribas Corporate & Investment Banking, dated 09 September 2014, discussing the economic and financial outlook for Latin America (Latam) and related global markets. It outlines the bank's strategy, market observations, and future expectations.

Main Points and Key Information

Domestic Market Overview (Brazil)

• Political Scenario: PSB’s Marina Silva is gaining increasing chances to be elected the new President, leading to high volatility and uncertainty.
• Risk Premium: The Brazilian risk premium has decreased, although this is considered exaggerated.
• Curve Flattening: The yield curve is flattening substantially, which is also considered exaggerated.
• State-Owned Companies: Stocks of state-owned companies are rallying.
• Strategic Actions:
  • Took profits on the inflation position in Brazil by long NTNB May 2015 and paying rates DI April 2015, with an entry at 6.13% and original target at 6.50%, current indicative level at 7.15% (PnL +23bps net of carry).
  • Entered a medium-term strategy of long NTN-B 2050 at 5.55%, based on the structural view of lower real interest rates.
  • Took profits on DI Jan-21 at 11.34% (PnL +44bps).
  • Short USDBRL 3m NDF at 2.3001.
  • Long NTN-B 2050 at 5.55%.
  • Long Soberanos 2017 at 3.65% YTM.
  • Receive IBR rates in Colombia (9m) at 4.43%.
  • Long CLPCOP at 3.325 (initial target at 3.50).

External Market Overview

• US Economy: Showing signs of steady growth and acceleration, with inflation relatively unresponsive. The US monetary policy normalization is expected to flatten the UST curve and push up the 10-year yield.
• European Economy: Showing signs of deceleration.
• China: PMIs above 50, supporting steady growth at 7.35-7.50%.
• Emerging Markets (EM): Incipient signs of equity flows rotation from Developed Markets (DM) to EM.
• US/EM Convergence: The bank's hypothesis is that EM will converge to both UST and US Corporates, stabilizing. Further improvement is only possible if UST 10-year yield drops to 2.30-2.35% for a considerable period.
• US Dollar: The market is expected to enter a stronger systematic USD stance in Q3-Q4 2014, leading to potential corrections after the recent rally.

Key Market Indicators

• UST Yield Curve:

  • Flattening is expected to continue, with the 10-year yield likely to rise.
  • The 10-year yield is currently at 2.50%, with a 1-year forward rate at 0.09% and a 2-year forward rate at 1.19%.
  • The spread between 10-year and 2-year yields is currently at 195bps and is expected to decrease.

• Interest Rate Positions:

  • Long 5Y CLPxCAM swap rate at 4.05%.
  • Short EURMXN, with a PnL of +260bps.
  • Long 5Y TIIE in Mexico, with a PnL of +35bps (net of carry +29bps).
  • Long 2Y Udi-bonos in Mexico, with a PnL of +23bps.
  • TIIE 2s5s flattener entered at 120bps, with a target of 75bps.
  • Short USDBRL 3m NDF at 2.3001.

• Emerging Markets:

  • EM continues to lag behind DM in growth dynamics.
  • The Economic Surprise Model shows a strong rebound into the positive camp.

Strategic Outlook

• The bank does not work with the hypothesis of a "new normal" or "new neutral".
• A sustained period of low volatility has led to a distorted sense of security, affecting risk premiums and creating asset overvaluation in some cases.
• The scenario for Q4 2014 is one of stabilization and small corrections, rather than a new trend of sell-off.
• Tactical positions should be taken to capitalize on over (under) shootings, such as Brazil DI, Brazilian Real, and Colombia swap positions.

Market Trends and Expectations

• The US economy is expected to continue accelerating, while Europe and Japan are expected to decelerate.
• The US monetary policy normalization is expected to lead to a flattening of the UST curve and a rise in the 10-year yield.
• The bank is neutral on Latam, except for specific positions in Mexico, Chile, and Brazil.
• The US is expected to maintain a stronger USD stance, leading to potential corrections after the rally.
• The Economic Surprise Model is expected to show continued improvement in the US, with a decline in the Eurozone and Emerging Markets.

Conclusion

The report outlines the bank's strategic positions and market expectations for Q3 and Q4 2014, highlighting the importance of monitoring the UST curve and taking tactical advantage of market movements. The focus is on a stabilization scenario rather than a new trend, with the expectation of continued US dollar strength and a convergence of EM to US and US corporate markets.