BNY’s Geoff Yu argues Latin American FX and equities now represent a single crowded ‘total return’ trade, with all regional currencies still overheld while bond holdings begin to reverse unevenly. In Mexico, expectations for lower rates are driving more FX hedging ahead of a likely 25 bp Banxico cut, even as sovereign bond demand stays firm.
Carry trade meets growing hedging pressures
“iFlow signaled throughout this year that Latin American equities and Latin American currencies are now essentially the same position: every Latin American currency remains net overheld. Until recently, every single sovereign bond market in the region was also comfortably overheld. Despite offering liquidity and good real yields to complement cautiously hawkish central banks, these holdings are finally starting to reverse, but progress is uneven.”
“In Mexico, we are seeing the clearest evidence yet that forward or even realized expectations for lower rates are starting to generate additional hedging interest, even if interest in sovereign bonds remain firm. As we head into the Banxico decision later this week, where a 25bp cut is expected, the market is likely viewing the Mexican policy approach as in stimulus/growth mode.”
“The question is whether the “total return” theme in Latin America can decline outright. Banxico does appear to be an outlier in global emerging markets, whereby the real rate buffer is being compressed to the absolute minimum (we believe 100bp is needed to justify positive real rates), but the central bank is pre-empting idiosyncratic downside risk.”
“Meanwhile idiosyncratic risk from the U.S. is high, both from swift transmission of less dovish policy expectations and any challenges in upcoming trade negotiations.”
“If markets (and the carry theme) are now “forward looking” enough in this respect, FX hedging will likely pick up in size, but fixed income can stay resilient as fiscal impulse is limited.”
(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)
