LatAm FX: Carry appeal faces Fed test – BNY

Geoff Yu at BNY sees Latin American (LatAm) assets benefiting again from improved terms of trade for energy and soft commodity exporters, with strong real-rate anchors supporting currencies and duration. However, he warns that rising U.S. yields and a less predictable Fed limit carry-trade momentum, keeping hedge ratios high even as some central banks like BanRep remain aggressively hawkish.

Commodity support versus Fed headwinds

"Market apprehension over the wider risk and growth environment should not detract from Latin America’s evident advantages. The initial phase of the conflict generated significant uplift in energy exporters in Q2, and we expect a repeat. As long as the real-rate anchor remains strong, terms-of-trade improvement will be reflected in the currency or duration, with the latter likely preferred by governments that are looking for more fiscal space."

"On a tactical basis, the case for Latin American holdings remains clear, but the carry trade momentum is clearly struggling despite flat positioning. We maintain our view that fixed income offers stronger risk-reward, but hedge ratios will likely remain higher until there is better visibility into the Fed’s intentions. The new challenge is that Kevin Warsh’s Fed may forgo forward guidance by design, necessitating structurally high hedge ratios."

"BanRep [Banco de la República] is expected to hike rates by 50bp to 12.50%, underscoring its status as the world’s most hawkish central bank. Real rates currently stand above 6%, but activity and demand levels remain robust. Retail sales continue to expand by double-digits on an annualized basis, and consumer confidence rebounded strongly in June."

"However, we note that the past week brought significant misses in EM policy decisions. The hitherto hawkish Bank Indonesia and South African Reserve Bank both chose to hold instead of hike, even with upside inflation risk."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)