Latin America: Duration favored over carry – BNY

Geoff Yu at BNY sees Brazil and Mexico operating in a more comfortable policy environment after the Fed decision, with anchored United States (US) front-end yields supporting emerging-market duration. Yu argues that Latin American sovereign debt offers better risk-reward than FX, given crowded positioning and limited upside, while softer U.S. real rates and Dollar weakness improve the inflation outlook through the import channel for regional assets.

Duration opportunity in Latam markets

“Central bank decisions in Brazil and Mexico will likely take place in a slightly more comfortable policy environment due to market reaction to the Fed decision. Front-end US yields are better anchored, and the breakout in US breakeven rates have significantly undermined the case for US real yields, which matters greatly for EM duration.”

“Asset selection remains challenging for the region. Contrary to our expectations, the global carry trade has failed to make much headway amid cross-asset volatility and challenging geopolitics.”

“The fall in dollar front-end rates has improved risk-reward, but we see more potential in sovereign debt. Latin American paper performed poorly through end-June and early July, leading to clear rebalancing potential toward month end.”

“With the decline in US real rates and dollar softness, the inflation outlook is set to improve further through the import channel, and the region is less exposed to global supply stress in any case.”

“Lower hedge ratios than envisaged is a good way to pick up some FX exposure in the meantime.”

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