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Conclusion: While a bullish catalyst in the long term (lower commodity-based inflation), King Dollar is weighing on Latin American economies and financial markets in the short term.

 

PRICES RULE

Latin America equity markets are getting rocked week-to-date, closing down -2.3% on a median basis. Declines are being led by Argentina (-7.3%), which remains our highest-conviction bearish thesis throughout the region’s equity markets. Latin American currencies are dropping as well, declining -1.5% week-to-date on a median basis vs. the USD. The Mexican peso (MXN) – a currency we’ve remained bearish on for 2+ quarters - is leading declines on both a short and intermediate term basis (down -3% wk-to-date; -13.6% in the last 6mo).

There hasn’t been much movement across Latin American fixed income markets in the week-to-date, though the broad-based declines in 10s/2s spreads is a signal to us that Slowing Growth hasn’t been fully priced in. Additionally, the -7bps week-to-date decline in Brazil’s 2yr sovereign debt yields on top of another -11bps decline in the country’s 1yr on-shore interest rate swaps signals to us that more rate cuts are likely on the way in Brazil. To that tune, the same 1yr swaps are trading a full -122bps below the 11.5% benchmark Selic rate. Colombia, which hasn’t begun to ease monetary policy after hiking +150bps YTD, are seeing their 1yr interest rate swaps trade down -26bps week-to-date – a full -311bps below the benchmark 4.5% minimum repo policy rate. All told, monetary easing across this region is incrementally supportive of our King Dollar thesis.

From a credit risk perspective, Latin American 5yr CDS are widening across the board, up +12.5% on a median basis in percentage terms. Deterioration is being led by Mexico, whose swaps have widened +14.2% (+18bps).

THE LEAST YOU NEED TO KNOW

Rather than delineate these data points by country, given the varying size and importance of these economies, we thought we’d try something different by grouping them by theme. Ideally, this should make it easier to absorb and contextualize anything of significance. Lastly, the callouts below are from the prior seven days:

Global Growth Slowing:

  • Brazilian industrial production growth slowed in September to -2% YoY vs. -0.1% prior, led by declines in durable and capital goods (down -9% and -5.5%, respectively).

King Dollar:

  • Brazilian giant Fibria Celulose SA, the world’s largest pulpmaker, posted the worst quarterly loss in company history in 3Q as the real’s (BRL) -16.9% decline vs. the U.S. dollar during the quarter increased the cost of servicing dollar-denominated debt in local currency terms. We’ve been aggressively hitting on the global side effects of a bullish buck breakout and Fibria’s 3Q earnings report is merely a microcosm of what’s happening internationally (see: Vale, Bharti Airtel, Turkish Airlines, etc.). Emerging market commodity-heavy and capital-intensive industries remain at most risk of underperformance, due to the double squeeze on revenues and debt service expenses. The latest YTD price action across the MSCI EM sector indices is supportive of our view.
  • The capital flight situation in Argentina has taken a turn for the worse, largely due to the recent spate of Big Government Intervention (forced corporate repatriation and banning certain forms of dollar purchases and requiring approval for others at a ~15% acceptance rate) following Fernandez’s landslide presidential victory. As an aside, in a effort to secure victory, she literally doubled public spending in September ahead of the October election. Slowing peso depreciation via selling dollars has pushed the country’s FX reserves down nearly -10% YTD to $47.4 billion – threatening to dramatically constrict the Fernandez’s plan to use $5.7 billion of these reserves to service international debt payments in 2012. As of now, Argentina’s “free and available reserves” (as defined by statute) are only $2.5 billion. The peso needs to drop another -7% from the current spot rate (holding the monetary base and FX reserves flat) to make her debt service scheme legally permissible – unless she decides to change the rules again!

Sticky Stagflation:

  • Peruvian CPI accelerated in October to +4.2% YoY vs. +3.7% prior. Recall that when we put out our note titled, “Shorting Peru” in mid-July, we said that Peru is one of the few economies globally that could have inflation accelerating through the end of the year. That still looks to be the case now.

Counterpoints:

  • Brazil’s manufacturing PMI ticked up in October to 46.5 vs. 45.5. Contracting still, but at a slower rate, which is positive on the margin.
  • Chilean industrial production growth and retail sales both accelerated on the margin in September to +5.2% YoY (vs. +1.7% prior) and +9.6% YoY (vs. +9.1% prior), respectively. Too bad it’s November and global crude prices have increased +6.5% since then (Brent). Thank Fed-head Tarullo for his late-October QE3 comments. 

Darius Dale

Analyst

Weekly Latin America Risk Monitor: Heavy Lies the Crown - 1

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