Fall in real rates to accelerate, FX pressures to mount
Most LatAm central banks have started cutting rates. Yet much lower inflation expectations means the real rate easing has not been as great and, in some cases, there has been real rate tightening. In order to ease, central banks can either cut faster or cut for longer, with the real rate easing accelerating after inflation has re-anchored. There has been increased comfort in inflation convergence to target (see Brazil and Peru). With inflation coming into the target range and expectations likely to level off, the stage is set for proper policy easing to begin.
Central banks have generally been cautious, and have found themselves behind the curve. An even sharper bout of disinflation or a sudden weakening of economic conditions may lead to an acceleration in the pace of cuts. For now, LatAm policymakers do not seem overly rushed, particularly as core central banks are also taking a more cautious approach to easing policy. We suggest hunting strategically and opportunistically across curves, including in inflation protected securities. We believe the best opportunities given the recent dynamics and outlook are where real rates remain unjustifiable elevated relative to neutral, such as Brazil and Mexico.
Local Rates: High real rates provide opportunity as inflation re-anchors. We continue to see a lot of value in various parts of the curve where real rates remain elevated. Our preferred trade remains receiving DI-26s as real rates remain very high in Brazil with room for compression. We also like some duration in Mexico, and see value in receiving further out, in the 5-10Y sector. In Chile, we prefer real rate receivers and synthetic inflation longs in the 1y sector (BTU 25 vs 1y CAM). In Peru, we continue to like local rates and note some opportunities to extend duration to PeruGB 32s/34s; however, we prefer to extend during a liability management operation.
FX: We generally prefer defensive FX positions across the region as the easing cycles erode the carry. The latest USD wave has helped our case, but not triggered massive carry trade unwinds. Further, several currencies remain rich and have stretched long positioning; and more easing (and potential for higher volatility, from very low levels) will affect the carry trade, leading to depreciations. This has already started for CLP and PEN. For more on FX themes and forecasts see our FX insights (link) and updated forecasts (link).