Since our last Asset Allocation analysis, we have been expecting Banco de México to begin an easing cycle on the back of inflation moderation and overly restrictive monetary conditions – not only because of real rates but also because of MXN appreciation in real terms. We continue to expect Banxico to cut rates again and move on with the easing cycle during the rest of the year, despite Thursday’s monetary pause.
In terms of real-rate strategies, we have been positioned at the long end of the Udibono curve (20Y), based on our inflation risk balance and because real-rate levels are attractive. We believe our stance remains valid. In addition, we were anticipating lower inflation expectations as measured by breakeven (BEI) in the belly (10Y) and the long end of the curve (20Y). Since we opened the strategy, BEIs have fallen nearly 40bp. We continue to anticipate lower inflation expectations, but there is room to take advantage of this.
As mentioned above, we are maintaining our stance regarding inflation moderation, though based on recent readings, we now see room for inflation to end the year above 4.0%. Meanwhile, the real curve has increased to maximum levels, leading to attractive entry points, especially in the 5Y-7Y section of the curve (Figure 1). Indeed, considering current levels, expected returns for the next six months are appealing under different scenarios in which the curve moves downwards (Figure 2). Therefore, in addition to our stance regarding the long end of Udibonos (20Y), we also see value in the 5Y-7Y section as the expected returns seem appealing.
In terms of carry roll-down, short-end Udibonos has proven to be more anchored than the rest of the curve. In addition, we do not expect an attractive accumulated inflation for the next six months, which means that carry will remain negative mostly in the short section of the curve, even considering 125bp of cuts from Banxico (Figure 3). In the belly of the curve (5Y-10Y), carry also remains negative but to a lesser extent. As yields remain at highs, expected returns should more than offset the negative carry. Therefore, we see value in the 5Y-7Y section of the Udibono curve.