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Market confusion over the near-term path of the USD has, in turn, lowered conviction for LatAm FX, which, as we wrote last time, explained 60% of the daily variation of LatAm FX returns.
It shows that investors pared back EMFX longs, reflecting reduced investor conviction in the trade backed by the positive fundamental picture. Yet we see the environment as one ripe for most EMFX longs to be maintained, but hedges to be initialized.
As such, we maintain our recommendations in BRL and ARS via a long ARS 3m NDF (as policy-makers have higher incentives to stabilize the exchange-rate market during wage negotiations), while also maintaining a long JPY/MXN position targeting 5.30.
The risks to MXN are well-known, which in our view will cause it to underperform in a positive environment for LatAm FX. Its mediocre performance in 2H February is the testament in our view that foreign investors – which had increased MXN positions YTD according to IMM data – attempted unsuccessfully to capitalize further on the time window in between NAFTA negotiations. Here on, the market focus is more likely now to shift from the idea that NAFTA negotiations are likely postponed to 2019, to the idea that a slow pace of negotiations could weaken the prospects of a deal ahead of the elections.
While investor focus seems still on NAFTA negotiations, we expect it will also start to shift to the uncertainty related to the presidential elections and the polls. With more than 4 months left, Morena’s lead can change – as in the past – particularly if other parties start to work more closely together to take advantage of the “anti-Morena” feeling. In our view, this would be an important dynamic to monitor for MXN.
Hence, stay UW MXN and add longs in 1m/5m calendar spreads (1m 18.50 MXN call and 5m 20.0 MXN put for 270bps). MXN outperformance can go in our view, as the expectation of the market for the balance of risks around NAFTA ahead of the Jan 24-28 negotiation round has improved. Courtesy: JPM
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