SHORT THE CHILEAN PESO?

Takeaway: We see real interest rate expectations dragging down the CLP another 10-15% vs. the USD from here amid unnecessarily easy monetary policy.

This note was originally published January 21, 2014 at 12:53 in Macro

SHORT THE CHILEAN PESO? - chile

CONCLUSIONS:

  1. Specifically, our GIP Model puts the Chilean economy squarely into Quad #2 (i.e. Growth Accelerating as Inflation Accelerates) for at least the next 3-6 months. By the end of 2Q14, we see Chilean CPI threatening the upside of the central bank’s 3% (+/- 100bps) target aided by a supportive base effect (i.e. easy comps) and annualized currency weakness.
  2. Ironically, this comes at a time when Central Bank President Rodrigo Vergara is stepping up dovish commentary amid the existing monetary easing cycle (-50bps of cuts since OCT).
  3. With the advent of this commentary, Chilean swap rates are hitting multi-year lows; the current 4.08% rate on the 1Y tenor is the lowest price since DEC ’10. Relative to the benchmark monetary policy rate, it has declined -10bps WoW to -42bps – effectively implying ~two additional rate cuts over the NTM. Assuming that comes to fruition, such policy would make absolutely no sense in the context of our intermediate-term GIP outlook for Chile.
  4. Moreover, with the Fed at least appearing set to continue tapering the pace of its asset purchases over the intermediate term, we think the spread between CLP and USD monetary policy will continue to diverge in favor of the USD – threatening to push the USD/CLP spot rate to/through the ~625 level over the intermediate term.
  5. Lastly, 1Y currency forwards are pricing at the ~565 level, implying our view is not within the realm of consensus expectations.

One of the things our Macro Team likes to do is make strategic calls on currencies – especially when our expectations for the country’s intermediate-to-long-term GIP (i.e. growth/inflation/policy) fundamentals diverge from consensus expectations or those of that country’s policymakers.

We don’t care if it’s a liquid currency like the AUD or the JPY (down -20% and -26%, respectively, since we outlined our bearish biases on 7/27/11 and 9/27/12, respectively) or an illiquid currency like the ARS or the VEF (down -42% and -32%, respectively, since we outlined our bearish biases on 11/4/10 and 10/9/12, respectively).

The CLP probably falls into the latter category, so we’re guessing this is roughly the point in the note where most of you lose interest. We’ve been actively covering the country for over four years now (along with the rest of Latin America) and this is the first note we’ve ever published exclusively regarding Chile.

For those of you who are inclined to continue on, we think the CLP has 10-15% downside from here as unnecessarily easy monetary policy weighs on real interest rate expectations.

Specifically, our GIP Model puts the Chilean economy squarely into Quad #2 (i.e. Growth Accelerating as Inflation Accelerates) for at least the next 3-6 months. By the end of 2Q14, we see Chilean CPI threatening the upside of the central bank’s 3% (+/- 100bps) target aided by a supportive base effect (i.e. easy comps) and annualized currency weakness.

SHORT THE CHILEAN PESO? - dale

SHORT THE CHILEAN PESO? - CPI

SHORT THE CHILEAN PESO? - CPI Comps

SHORT THE CHILEAN PESO? - FX

Ironically, this comes at a time when Central Bank President Rodrigo Vergara is stepping up dovish commentary amid the existing monetary easing cycle (-50bps of cuts since OCT):

“There is a probability that we have an expansive monetary policy going forward. We don’t think it will be massive, that a huge monetary stimulus is needed, but there is a probability that an additional monetary push will be required. Faster inflation in the past two months is transitory, with little sign of wage pressures or international energy and food costs pushing price-increases toward the top of the target range in the foreseeable future.”

It’s not exactly as if the Chilean central bank was leaning hawkish when it kept rates on hold last week, so we think Vergara’s commentary represents a step forward in dovish guidance:

“The Chilean economy has continued to lose strength. The board estimates that in the coming months it might be necessary to increase the monetary stimulus to ensure that projected inflation will stand at 3 percent in the policy horizon.”

With the advent of this commentary, Chilean swap rates are hitting multi-year lows; the current 4.08% rate on the 1Y tenor is the lowest price since DEC ’10. Relative to the benchmark monetary policy rate, it has declined -10bps WoW to -42bps – effectively implying ~two additional rate cuts over the NTM. Assuming that comes to fruition, such policy would make absolutely no sense in the context of our intermediate-term GIP outlook for Chile.

SHORT THE CHILEAN PESO? - Swaps

Keep in mind that our call for Chilean inflation to accelerate over the intermediate term is in line with our #InflationAccelerating Q1 Macro Theme:

“Across the globe, reported inflation readings are poised to accelerate from post-crisis lows as easy comps, a commodity base effect and accelerating wage pressures all come to a head in the first quarter of 2014. Moreover, the reemergence of inflation as a core macro risk threatens to materially alter the investment landscape going forward.”

Moreover, with the Fed at least appearing set to continue tapering the pace of its asset purchases over the intermediate term, we think the spread between CLP and USD monetary policy will continue to diverge in favor of the USD – threatening to push the USD/CLP spot rate to/through the ~625 level over the intermediate term.

Structurally speaking, the Chilean peso is a dog. Chile scores very poorly on Pillar I of our proprietary EM Crisis Risk Model (i.e. BoP/Currency Crisis Risk), which is designed to rank emerging market economies according to their level of risk by capturing deviations from the sample mean across key metrics. Some noteworthy lowlights for Chile:

  • A bloated current account deficit of -3.4% (3Q13); and
  • A structurally-impaired outlook for the current account with the busted bubble that is commodities accounting for 85.8% of exports (2012 annual data).

SHORT THE CHILEAN PESO? - PILLAR I

SHORT THE CHILEAN PESO? - EXPLANATION TABLE

Lastly, 1Y currency forwards are pricing at the ~565 level, implying our view is not within the realm of consensus expectations. Recall that there are three main “states” for consensus to adopt with respect to contrarian investing:

  1. Bullish enough
  2. Bearish enough
  3. Not enough of either

SHORT THE CHILEAN PESO? - USDCLP NDF

Right now, we think consensus is a clear #3 with respect to the Chilean peso. Happy shorting,

DD

Darius Dale

Associate: Macro Team