Conclusion: Central banks are positioning themselves for monetary easing alongside a regional deterioration in capital markets activity, which should support continued weakness in Latin American currencies especially vis-à-vis the U.S. dollar.
Latin American equity markets had a particularly strong week, closing up +6.3% wk/wk on a median basis. Gains were headed by the high-beta Argentine equity market, which closed up +16.8% wk/wk. Despite the region’s benchmark equity markets being down -19% YTD, we are choosing to ignore the allure of perceived valuation and remain bearish here over the intermediate-term TREND. Our expectations of a pending Correlation Crash should eventually take prices lower and provide much more attractive entry points on the long side of LatAm equities.
Regional currencies also had a particularly strong week, closing up +1.9% wk/wk on a median basis vs. the USD. Gains here were capped by the Chilean peso, which advanced nearly 4% on the week. The Mexican peso, a currency we have had a negative fundamental view on since Q2, is down -11.5% vs. the USD over the past three months alone. We think there is more downside to come, as expectations of central bank easing continue to feed upon themselves (1yr interest rate swaps fell another -3bps wk/wk and are now pricing in a mere +8bps of tightening over the NTM – down from +63bps at the start of the year. This was reinforced across Mexico’s sovereign debt maturity curve, with 2yr, 10yr, and 30yr yields falling -5bps, -30bps, and -32bps wk/wk, respectively.
Regional CDS (5yr) broadly declined last week, narrowing -16.3% wk/wk on a median basis from a percentage perspective. Individual declines were led by Colombia, which tightened -35bps wk/wk for a percentage decline of -18.3%. We’ve been vocal in our call that the trend in LatAm credit risk is up as global growth slows and commodity prices deflate and prices are in confirmation of that – regional 5yr CDS have widened +52.4% on a median basis over the last six months, headlined by Chile’s +120.5% widening (likely related to its exposure to China/copper prices).
***price tables can be found at the bottom of this note***
The Least You Need to Know
- The Senate budget committee sees what we saw: higher government expenditures in 2012 (by +R$25.6 billion to be exact), with lower growth (they lowered their 2012 GDP estimate to +4.5% vs. a previous forecast of +5%). Interestingly, they increased their inflation projection to +6%, which is confirming of the central bank’s private economist survey that showed a seventh straight weekly increase in their 2012 inflation projection (now at +5.61%). We’re bearish enough on commodities over the intermediate term to take a variant view on the CPI front.
- External corporate debt sales by Brazilian companies have fallen below last year’s record pace for the first time ($32.3 billion YTD, down -1.2% YoY), as LatAm capital markets continue to dry up, on the margin. Given the headwinds of securing equity financing (Bovespa finished the week down -20.6% YTD), a closure of Brazil’s (and other regional) corporate bond markets would be an incremental negative as it relates to financing economic growth across the region.
- Brazil’s securities and exchange commission (CVM) is stepping up investigations into and efforts towards combatting insider trading surrounding earnings releases, as well as central bank front-running in the interest rate futures market. According to Brazilian newspaper O Globlo, “two or three banks” completely and abruptly changed their interest rate exposure immediately before August’s “surprise” rate cut. We use quotations around the word “surprise” because neither the markets nor our research would’ve suggested to expect anything other than monetary easing out of Banco Sentral do Brasil at the time of the actual cut – which is now expected by the market to be added to at Wednesday’s monetary policy meeting.
- As alluded to earlier, Mexican capital markets are indeed pricing in some form of monetary easing out Banxico over the short-to-intermediate-term. Last week, they kept their benchmark policy rate on hold at 4.5%, but opened the door to the possibility of a rate cut by saying: “[We] will remain alert to global economic growth perspectives and the possible implications for Mexico’s economy, which in the context of extensive monetary easing in the largest industrialized countries, subsequently could make it appropriate to relax monetary policy [in Mexico].” Having not raised rates once since the global economic recovery began nearly two years ago, we do not think IMF-trained central bank governor Augustin Carstens will be able to resist the Keynesian urge to ease policy in the coming months. As such, we remain bearish on Mexico’s currency, the peso, vs. the USD from a TREND perspective.
- Chile also kept its benchmark policy rate on hold, at a respectable 5.25% (after having hiked +250bps in the LTM). Like Mexico, Chile’s central bankers opened the door for monetary easing later in the year, by acknowledging that growth is slowing more than expected due to waning global demand. Chile’s currency, the peso (CLP), remains at risk vs. the USD over the intermediate term due to the confluence of potential monetary easing (-77bps of rate cuts priced into the 1yr swaps market) and waning demand for Chilean exports (copper failed to overtake any of our key quantitative levels of resistance amid the global V-bottom rally we’ve just witnessed).
- A poll published Oct 9 by Poliarquia Consultores showed that incumbent president Cristina Fernandez has the support of 52-55% of voters heading into the Oct 23 presidential election. The closest challenger, Hermes Binner, garnered only 14-16% of the vote. A first-round win by the current leader continues to be the expectations of both the market and voters – many of whom she has bought off by increasing social spending and publically-negotiated wages in recent months.
- Speculation surrounding a likely Fernandez victory and the likelihood that she will continue her late husband’s policy of systematically underreporting of CPI is handing investors in Argentina’s inflation-linked bonds the worst relative performance to the region since 2008 (-28.5% YTD vs. a regional average of -14.5% YTD).
- As capital flight ensues (largely driven by speculation that Fernandez will seek to devalue the Argentine peso in coming months), the country’s benchmark deposit rate, the badlar (rate on 30-day deposits > 1 million pesos), has increased to the highest level since Jan ’09, closing the week at 15.7% and 11.4% on a 30-day M.A. basis (highest since Nov ’09). As a comparison, the yield on 30-day Brazilian certificates of deposit has declined -35bps in the past month to 11.45%.
- In what is arguably a particularly ominous sign for the global economic cycle and capital markets activity, Argentine companies are selling the most asset-backed debt in 11yrs (+4.5 billion), while increasing the proportion of asset-backed debt to total issuance to the highest ratio since 2008 (67%). The growing inability for Argentine borrowers to economically price unsecured debt has contributed an -8% YoY decline in dollar-bond issuance YTD. A key risk to flag here is that banks and retailers are leading the issuance YTD (58% of the total) and are accelerating consumer lending heading into an economic downturn (revolving consumer credit increased +37.2% in Sept), likely in order to grow assets to back their debt issuance with – vaguely reminiscent of the U.S. subprime mortgage crisis. This isn’t the kind of data point you want to see if you are among the many who think they bought the bottom when we made our Short Covering Opportunity call on 10/4.