Betting Latin American swap rate curves will shift lower has emerged as a hot new trade as local inflation cools and investors see the Federal Reserve pausing its monetary tightening cycle.
(Bloomberg) — Betting Latin American swap rate curves will shift lower has emerged as a hot new trade as local inflation cools and investors see the Federal Reserve pausing its monetary tightening cycle.
Traders have rushed into the high-yielding receivers, a position that profits from falling interest rates, since mid-March — when traders began to see a potential halt in US rate hikes.
In Brazil, the DI contract maturing in January 2027 dropped 183 basis points since then. The five-year TIIE in Mexico saw a full percentage point decline in the span.
“The risk is now biased to lower rates, since the skew is tilted not to a big inflation surprise but to a downside growth surprise,” said Drausio Giacomelli, the head of emerging-market research at Deutsche Bank. “Brazil is our favorite receiver,” he added.
While Brazil and Mexico are the most obvious bets due to the higher liquidity of their markets, Andean countries have also joined the rally. Five-year IBR swap rates in Colombia are at 8.83% versus 10.55% in the first week of March. The positive mood with the region helped markets quickly erase the losses seen after President Gustavo Petro reshuffled his cabinet, and shrug off inflation data that’s proven more stubborn than in the rest of Latin America.
The main risk for the trade is the Fed failing to deliver the priced-in rate cuts. Currently, the curve prices in rates nearly 75 basis points lower until December, even though policymakers haven’t clearly pivoted to a dovish stance yet.
“Latin America is where you want to be receiving,” said Luis Hurtado, a strategist at CIBC. “The market has moved ahead of the Fed too much and I think they’re going to hold the rest of this year. But Latam central banks were the first to hike so they will be the first to cut.”
Short-end of swap curves show Brazil and Chile are set to be the first to start an easing cycle. Chile’s Camara prices in 147 basis points in cuts over the next six months, while Brazil’s DI curve implies the benchmark Selic rate will be 133 basis points lower by the end of the year.
Read more: Chile Set to Hold Rates Again on Hot Core Prices: Decision Guide
Chile’s central bank meets Friday and is expected to hold rates steady in a decision to be announced after close.
–With assistance from Maria Elena Vizcaino.
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