FxWirePro: Hedge or no hedge, the driving forces of LatAM FX space

These past weeks’ price action has tested our resolve: global forces like the possible change of Fed Chair or possible US tax reform have naturally changed the USD outlook.

In addition, less positive news particularly on the Brazil reform agenda and on NAFTA have exacerbated BRL and MXN weakness relative to other EMFX. Yet in our view LatAm’s FX risk-reward is now balanced: 1) The global environment of higher growth and lower inflation still favors EM and particularly LatAm, in our view, though this seems to have become consensus,

2) The positioning unwind leaves room for counter-rallies on the back of more positive domestic news or central bank intervention. We thus maintain an overall neutral stance, and like tactical long BRL and PEN positions, as well as short CLP/COP targeting 4.60.

It is expected that MXN to stabilize around 18.80 on domestic and NAFTA considerations. We mentioned MXN hedges at these levels were no longer necessary, yet admittedly further high-carry FX weakness will continue to spill-over into MXN as the typical hedging currency for the asset class. Banxico’s announcement to intervene with an additional $4bn shall also limit volatility in MXN, but more importantly, this opens the door for more intervention in the short term, putting a floor on MXN weakness, in our view.

Short ZAR-MXN, targeting a move toward 1.29, we recommend a short ZAR-MXN position, currently trading at 1.3938.

We target a 7.5% move lower to 1.2893, and place a stop-loss at 1.4356.

Our trade horizon is 3-4 months. The position costs about 2bp per month in carry. Courtesy: JPM