Morning Note /

Latam Daily: Brazilian hedge funds suffer as investors flock to bonds

  • Talking Points: IMF concluded its consultation of Mexico in Article IV

  • Forex: Colombian Peso bucks broader strengthening in LatAm currencies on Friday

  • Fixed Income: Brazilian hedge funds take a blow as rising interest rates triggers a rotation into bonds

Kieran Siney
Kieran Siney

Head of African Markets

Daron Hendricks
Danny Greeff
ETM Analytics
8 November 2021
Published by

Talking Points: IMF concluded its consultation of Mexico in Article IV

Brazil: While inflation risks remain elevated, to say the least, the government announced a raft of measures to ease the pressure on consumers’ pockets on Friday. The Economy Ministry said in a statement released on Friday that the government decided to reduce by 10% the import tax rates on 87% of the tariff codes that make up the Mercosur Common Nomenclature. The Ministry said that the reduction, which is temporary and exceptional, covers items such as beans, meat, pasta, cookies, rice, construction materials, among others. The reduction in import duties aims to alleviate price increases in various sectors of the economy and for the final consumer. The reduction of import tax rates will take effect from November 12 and will be valid until December 31, 2022.

As always, the new week brings with it the central bank economist survey, which will provide traders with the latest forecasts on GDP, FX, inflation and Selic rate. Recall that economists raised their estimates for the Selic rate in 2022 to 10.25% from 9.50% last week. The upward revision to inflation and interest rate forecasts resulted in some fresh directional impetus for both the fixed income and FX markets last week. Today will also see the release of several second-tier data prints. Given the sensitivity of markets to monetary policy dynamics at the moment, a surprise in the FGV inflation numbers have the potential to result in some price action for local assets.

Mexico: On Friday, the International Monetary Fund (IMF) concluded its consultation of Mexico in Article IV, in which the directors generally see merit in additional targeted fiscal support, using available space for health and education, social safety nets and quality public investment, while also commending Mexican officials for maintaining economic stability through a challenging period. The domestic economy continues to rebound despite further Covid-19 waves and supply chain waves, and given Mexico’s low long-run growth performance, the IMF underscored the need to safeguard the recovery and promote stronger, more inclusive, and greener growth. The IMF also recommended raising spending by 1.5% of GDP in 2022. At the same time, measures to contain rising pension costs and reforms to Pemex’s business plan are needed.

It’s a busy start to the week with gross fixed investment activity figures together with vehicle production and export data scheduled for release. Focusing on gross fixed investment activity (GFI), the trend of declining y/y figures can be expected for August due to statistical base effects. On a m/m basis, the rebound in July with a growth of 2.14% may stall due to the headwinds from tight fiscal policy and the government’s nationalist agenda. Moreover, recovering activity in construction should support investment into the sector, but not enough to convincingly sustain a rebound in GFI going forward.

Colombia: Today, the market will have the October edition of the consumer confidence index to digest, which is expected to show a continued recovery from the deterioration in sentiment through H1. The index is expected to reflect improving consumer psychology as the recovery from the nationwide demonstrations earlier in the year subsided and COVID-19 cases declined. Whether this improvement can be sustained amid rising inflationary pressures, however, remains to be seen, although, for now, improving economic conditions appear to be supporting demand-side sentiment.

Chile: The political landscape is red hot at the moment and it certainly has the news wires focused as we have final two weeks ahead of us before the 21 November Presidential election. As it stands now, we have the conservative candidate Jose Antonio Kast in the lead, according to the polls. Bloomberg reported that Kast got 44% of support while leftist rival Gabriel Boric got 40% in a second-round vote, according to a survey by Cadem released Friday. Kast would also edge out Yasna Provost​e in a runoff by a 42% to 41% result that falls within the poll’s margin of error.

Peru: Peruvian Finance Minister Pedro Francke asked a congressional committee on Friday to support the government's tax reform plans. He said that he would seek to increase the country's capital gains tax from 5% to 10% and impose a tax on dividends earned by companies. Additionally, Francke noted that companies that enjoy legal stability agreements would need to pay 2% more on income taxes. These measures would aim to shore up Peru's fiscus after the hit it took during the pandemic while also helping to fund the Castillo administration's push for a more equitable society.

Forex: Colombian Peso bucks broader strengthening in LatAm currencies on Friday

Brazil: It was an upbeat end to the week for the BRL, with the local currency closing Friday’s session 1.09% firmer against the USD at 5.5423. The appreciation in the BRL came on the back of an improvement in global risk sentiment and a modest pullback in the greenback. It was a strange reaction to what were robust non-farm payrolls data out of the US. However, as has taken place many times before, the amount of good news priced in US markets far exceeded the outcome, and the market sold off into the weekend. Practically speaking, the US still faces enormous twin deficits that, if anything, might be exacerbated by the recovery in the labour market and the potential strengthening of the credit cycle that could follow. Looking at the session ahead, the USD has kicked off the new week on the back foot, pointing to a positive start to the session for the BRL.

Mexico: The MXN regained its footing last week after the Federal Reserve adopted a dovish stance at its latest policy meeting and upbeat US labour data, which resulted in the trade-weighted DXY trading in a tight range without clear direction. On Friday, the MXN strengthened past the 20.500/USD level, which acted as a barrier for much of the week as it looked to challenge the 20.300/USD mark before closing at 20.3434/USD. As a result, the MXN led EM currency gains last week, advancing 2.63% against the USD, securing a positive start to the month.

At the start of the new week, risk appetite has turned more cautious as investors await US CPI and PPI data this week, in the absence of significant triggers today. The USD-MXN is bid ahead of the US open and is looking to climb above the 38.2% Fibo retracement level at 20.3756, which could lead the pair to the 50.0% Fibo level 20.61619 if the buyers get involved. There is limited room to the downside due to the cluster of technical indicators between 20.1500 and 20.2830. Local data releases are expected to influence the spot market.

Colombia: The COP's bear-run extended into the weekend, with the currency bucking broader regional currency strength with a 0.25% decline on Friday. With this, the COP ended the week nearly 3.00% weaker than what it started, trading at levels last seen in August. Friday's move also occurred despite rising oil prices, with further weakness potentially on the cards at the start of the new week after CPI data came out softer than expected after the session's close.

Chile: In terms of the local unit it is more of the same. Consolidation is the order of the day, we sell on levels approaching 820 and buy on levels approaching 805.

Peru: In line with its emerging market peers, the PEN ended Friday’s session in the green against the USD. That said, relative to its EM peers, the gains in the PEN were modest, with the local currency strengthening by 0.08% to end the day at 4.0105, according to Bloomberg data. The gains in the PEN were partly due to an improvement in global risk sentiment following the better than expected US jobs report on Friday. Although the local unit firmed on Friday, the broader bearish bias remains intact with the PEN closing the week 0.48% in the red against the USD. Note that since the start of the year, the PEN has depreciated by 10.73% against the USD. 

Fixed Income: Brazilian hedge funds take a blow as rising interest rates triggers a rotation into bonds

Brazil: Data published by Brazil’s capital markets association Anbima showed that Brazilian hedge funds are taking a beating as the spike in interest rates increases the appeal of fixed income assets and detracts from equities. The BCB has embarked on an aggressive rate hiking cycle this year to quell inflation which has surged to double-digit territory amid persistent weakness in the currency and soaring food and energy costs. Note that the central bank has hiked the benchmark Selic rate by 575bps since March to 7.75%.

Specifically, investors withdrew around BRL 12.5bn from domestic hedge funds in October. This comes on the back of a BRL13.4bn net outflow in September. A breakdown of the data showed that fixed-income funds and exchange-traded funds recorded net inflows in October, while pension funds, FX funds, equity funds and hedge funds all recorded net outflows.

Until the second half of this year, Brazil was running low interest rates, which had encouraged investors to favour high yielding, riskier assets over government bonds and other fixed-income instruments as investors hunted for yield. For context, fixed-income funds saw a net inflow of BRL17.4bn in October, bringing the year to date net inflow into fixed-income funds to BRL 255bn. Anbima noted that this is the largest net inflow into fixed-income funds for the period January to October since the association started tracking the data.

Going forward, given the inflation problem that Brazil finds itself in, we expect the central bank to continue hiking rates aggressively in the months ahead to ensure that consumer prices don’t spiral out of control. As such, retail investors are likely to continue rotating from riskier assets into fixed income instruments. Moreover, we expect that the outflows from hedge funds are likely to continue in the months ahead.

Mexico: Mexican bonds strengthened on Friday and more broadly over the week, unwinding some of the bear flattening bias recorded along the sovereign yield curve in recent weeks, which was partly due to a moderation in inflation expectations. As a result, investors scaled back some of their monetary policy tightening expectations. The local swaps market has illustrated this, with rates falling in the back-end of the week after surging earlier last week. The 2yr swap rate dropped 12bps on Friday, outpacing global peers and extending a three-day drop to 25bps, the steepest in almost seven months. Still, the market is pricing in around 180bps worth of rate hike risk a year out. Banxico will update its monetary policy this week and is seen raising its overnight rate from 4.75% to 5.00%.

Colombia: Finally, the Colombian yield curve's flattening trend halted on Friday as front-end yields declined while long-end yields rose. This could potentially suggest that investors are ready to re-enter the market after the sharp selloff of front-end bonds. That CPI data on Friday came out softer than expected will likely only reinforce this, with front-end bonds likely to be deemed more attractive in an environment of slowing inflation and a less-aggressive BanRep rates outlook.

Chile: The current political and fiscal risks are certainly finding expression in the 5yr CDS which has risen from a low of 43 bpts in February to 79 bpts as we enter the new week. Granted we have pared back from the highs seen closer to 90 bpts over the October measurement period and this may have something to do with the fact that it looks like the right are in the lead on the presidential race front. The conversative will most certainly be more business friendly and less likely to ramp up taxes and spending, even though they will need to be more accommodative than they have in the past to secure social cohesion.

Peru: The flattening bias in Peru’s bond curve persisted last week with the 10v2 yield spread compressing by 15bps to 212bps, its lowest level since March last year when the COVID-19 pandemic first set its grip on the country. Underpinning the flattening bias in Peru’s bond curve last week was a combination of improved risk appetite, which saw yields on the long end of the curve nudge lower while soaring inflation expectations drove up risks on the front end of the curve as traders priced for more hawkish monetary policy. Going forward, with inflation risks skewed firmly to the upside, we expect the flattening bias in the bond curve to persist through to the end of the year.