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Deutsche Bank Note Deep Fiscal Problems Exposed

LATAM
  • Deutsche Bank saw the correction in LatAm local markets in mid-April as structurally different than the previous jitters in global rates, and believe that recent developments validate those fears. Fiscal stance and its impact on neutral rates played an important role in that repricing, which exposed LatAm as the region with deeper fiscal problems. Within LatAm, Brazil followed by Colombia stood out, but Mexico’s constitutional reforms also pose a significant risk.
  • DB expect LatAm to be unsettled until there’s clarity on the adoption of measures, which may inject uncertainty to the region’s macroeconomic and institutional backdrop, and/or the global risk sentiment turns more favourable. Shifts along those lines would tame volatility, re-anchor FX, and provide central banks the necessary ability to adjust and resume their cycles accordingly.
    • Within FX, DB see the high yielders, BRL, MXN, and COP as most vulnerable still on strong outflows (BRL) and vulnerable positioning and valuations (MXN, COP). By contrast, they expect CLP and PEN to trade mostly on external drivers, with CLP valuations most appealing. Should the ongoing jitters dissipate due to a more constructive outlook, DB see more room for BRL and MXN to recover and outperform.
    • Within LatAm fixed income, pricing is most stretched in Mexico. However Brazil has made more progress in absorbing multiple social pressures over the years, which leads DB to view Brazil more favourably. By contrast, Peru and Chile offer much less premium, although Peru’s curve is quite steep.
    • Overall, DB find that all curves overprice the policy paths they foresee, and FX forwards overprice FX risks. However, premia are not yet extreme to provide credible backstops, and regaining investors’ confidence may take some time.
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