Although the TIIE curve rallied during the latest week, markets are still pointing north on persistent uncertainty regarding the future path of Banco de México’s monetary policy decision. The TIIE curve is pricing in between 130bp and 240bp of hikes in the next six months to one year, and a terminal benchmark rate close to 8.00% as soon as in 2023. Even though the implied monetary policy in the curve is more restrictive than our base scenario, the uncertainty surrounding Banco de México’s coming decisions would make the TIIE curve to continue pricing in a restrictive stance. Meanwhile, swap spreads decreased as MBono price action during recent weeks was more aggressive than in the TIIEs. However, as we stated in our previous radars, swap spreads tend to increase when Banxico tightens conditions. Therefore, we would expect them to correct to the upside in the short term.
In terms of carry roll-down, considering a 6-month horizon, drip continues to be attractive at the short end of the curve, especially in the 9M and 1Y tenors (nearly 130bp on average) as markets are factoring in a more aggressive approach from the central bank. While we believe nominal curves are attractive across various tenors, especially at the short end, we are maintaining our neutral stance as there is no clear signs of an adjustment in the short run. We also prefer the belly of the curve as in our view the risks to growth imply further flattening in 2022.
In terms of slopes, the TIIE curve has flattened between the short end and the belly. Indeed, spreads are on average close to their 15th-20th percentile considering history since 2010, as the short end has increased more than the belly and the long end of the curve. At the short end, however, spreads remain distorted; indeed, the 1Y/2Y slope spread is close to its 70th percentile as markets have moved to price in more hikes from Banxico. Meanwhile, in the 5Y/10Y slope, the spread is at minimum levels (close to their 1st percentile). As we already said, the curve distortions would probably prevail in the near term, which means that the 5Y/10Y spread could remain at minimums. Nevertheless, once Banxico’s approach becomes clearer, the spread could probably increase.
The drip cost of a flattening strategy is around 42bp between the short end (2Y) and the belly (10Y). In terms of forwards, the 2Y/10Y slope is pricing in an additional flattening of 25bp. We reiterate that, as a directional trade, we continue to anticipate lower slopes because activity risks will prevail, and the CB is already immersed in a tightening cycle. As a result, there is room for further flattening and an inversion of the curve.
Regarding butterflies, spreads at the short end (1Y-7Y) are at maximum levels, close to their percentile 90th on average. Flattening strategies are expensive in that section of the curve because of recent carry roll-down levels. Meanwhile, butterflies between the short end, the belly, and the long end of the curve are now negative, and their levels are actually at their lowest percentile.
In terms of drip costs, 2/10/20, 3/10/20 and 7/10/20 butterflies are expensive, close to 50bp on average, which means that a flattening/steepening of more than 50bp is necessary to make profits and presently there is no room to take relative value strategies. Additionally, 5/10/20 and 7/10/20 butterflies are also negative, but their drip cost is less expensive (close to 15bp on average). Still, as we have mentioned before, curve distortions would probably prevail in the near term
Finally, FRAs remain above spot levels in the entire curve. Spreads at the short end (from the 3M to the 1Y) continue to increase because forwards have moved more than spot rates. Therefore, receiving forward rates and paying spot rates continues to make sense in that section. In the 5Y (3Y/2Y) and 10Y (5Y/5Y vs. 10Y), spreads seem tight because they have recently decreased and are close to zero as the 10Y and 5Y spot rates climbed more than the forward rate.