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At Hedgeye, we firmly believe risk is always “on”. Latin American financial markets would certainly attest to this contrarian mantra.


Last week was a rough week for Latin American equity investors, with the region’s indices closing down -2.5% wk/wk on average and falling -3% wk/wk on a median basis. Argentina led the way to the downside, plunging -4.1% wk/wk, while Colombia’s -0.3% wk/wk decline outperformed amid a sea of red.

Falling expectations for further monetary tightening and outright speculation for monetary loosening continues to weigh on Latin American FX markets, with our least favorite – the Mexican peso – leading the way to downside (-2.2% wk/wk vs. the USD). Interest rates across Latin America’s sovereign debt markets continued their recent trend of declines – particularly on the short end of the curve, where monetary policy tends to have a more forceful impact. Interestingly, rates on the long-end of Mexico’s sovereign debt curve backed up fairly meaningfully wk/wk. The -3.8% wk/wk decline in Mexico’s IPC Index and the central bank’s own bearish commentary do not suggest that this widening of Mexico’s yield curve should be interpreted as heightened growth expectations, however.

Latin American sovereign CDS broadly widened wk/wk, with Colombia and Peru leading the way on a percentage basis (up +12.9% and +11.4%, respectively). The recent broad-based trend of higher-highs and higher-lows remains intact.

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Brazil: Brazilian economic data remains flat-out terrible and has been for much of the last 3-4 quarters, yet Brazilian financial markets continue to signal there is more bad data to come (equities, currency, bond yields – all down wk/wk). The most recent spate of Sticky Stagflation on a reported basis came in the form of slowing real GDP growth (+3.1% YoY in 2Q vs. +4.2% prior) and accelerating CPI (+7.2% YoY in Aug – a six year high – vs. +6.9% prior). Even Brazil’s oft-bandied about domestic demand is slowing, with the Aug services PMI reading ticking down to 52.2 (vs. 53.7 prior).

Obviously with the recent rate cut, combating slowing growth remains atop Brazilian policymakers’ collective agenda. In fact, Finance Minister Guido Mantega said that Brazil has a “great deal of room to maneuver” in both monetary and fiscal policy (though he did confirm that officials would prefer not to use the fiscal stimulus – a much-needed sign of fiscal conservatism). Absent a material unwinding of the European banking system, we continue to believe that much of Brazil’s stimulus efforts will come in the form of interest rate cuts, due to mounting political pressure to lower the country’s real interest rate/debt service burden, as well as the simple fact that the Rousseff administration has shown that it has its hands full with containing nominal expenditure growth in the upcoming federal budget.

An interesting callout that we wanted to flag was the rate of DPGE debt being issued by mid-sized Brazilian banks (R$8.5B YTD vs. R$6.3B in all of ’10). The bonds, which are backed by the country’s depoisit insurance fund, have essentially become a source of last-resort funding for Brazilian lenders after the Banco Panamericano scandal all but evaporated the loan portfolio market. Obviously, we’re a long way away from a crisis, but the risk that mid-sized banks in Brazil face heightened liquidity risk in 2012 is an important one to flag, as government incentives for larger banks to buy bonds or loan books from smaller banks get phased out.

Mexico: Mexican economic data continues to support our bearish intermediate-term view of the Mexican peso and Mexican equities: consumer confidence ticked down in Aug to 93.4 (vs. 95.5 prior); manufacturing PMI ticked down in Aug to 51.5 (vs. 50.1 prior); services PMI ticked down in Aug to 52 (vs. 52.5 prior); and CPI slowed in Aug to +3.6% YoY (vs. +3.6% prior) – which is negative for expectations for tighter monetary policy (MXN-bearish). In fact, of the 47 currencies we track, the Mexican peso’s -9.2% decline vs. the USD over the last two months is only bested by the Polish zloty’s -9.5% decline.

Chile: Sticky Stagflation continues to dominate both headlines and headline economic data in Chile. From a headline perspective, the central bank lowered the top end of its 2011 real GDP growth forecast -75bps to +6.25% YoY. Currently growing at an +8.2% pace YTD, their outlook clearly implies a meaningful drop-off in Chilean economic activity in 2H – which is in line with what our models were signaling much earlier in the year and continue to signal. On the inflation front, CPI accelerated in August, supportive of the central bank’s recent statement that it was “too early to cut interest rates”. Elevated rates of reported inflation are likely to continue to keep many central banks in a box and prevent them from easing monetary policy in a proactive manner and Chile is no exception in this regard.

Colombia: Political pressure on Colombia’s central bank to cut interest rates continues to grow and a marginally dovish inflation reading for Aug only amplified those claims (CPI slowed to +3.3% YoY vs. +3.4% prior). President Juan Manuel Santos blatantly asked the central bank to refrain from raising interest rates early last week and subsequently tweeted, “There is no reason to raise rates.” Moreover, he publically stated that he “remains concerned about the strength of the [Colombian] peso” (COP). While Colombia’s 2yr sovereign debt yields have fallen -66bps over the last three months, they remain a regional outlier from a YTD perspective (up +57bps) and this tug-of-war should eventually culminate with the central bank giving in to the President’s demands (our models have Colombian GDP growth slowing in 2H11).

Darius Dale