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Goldman Sachs on COP: High-Risk, High Carry, High Premium

COLOMBIA
  • For now, Goldman Sachs remain comfortable in having excluded COP from their efforts to find the right EM FX carry trade; however, if mid-March comes and goes without left-tail policy risks being realized, if inflation shows signs of falling, and if external balances improve from current levels, the combination of high carry and deep risk premium could begin to improve the risk-reward of longs in the Peso.
  • Much of COP weakness appears driven by increasing domestic policy uncertainty: in particular, the unveiling of the national development plan, the introduction of an ambitious health reform bill, and the expectation of additional policy reforms to be submitted to congress in mid-March, including major pension and labor reforms, have extended investor concerns around the possibility of market-unfriendly policy steps in Colombia.
  • Set against this policy mix, the Colombian economy is also showing more consistent signs of slowing down, even as inflation shows few signs of slowing, and external balances remain challenged.
  • The balance of risk premia has begun to shift in LatAm FX: as idiosyncratic domestic issues have driven COP significantly weaker than what would have been implied by its FX peers and global markets, COP now features the largest risk premium in LatAm FX, on GS metrics, while CLP’s risk premium has compressed significantly from its deepest levels. And, with global FX investors still focused on the theme of EM FX carry, the Peso’s top-tier carry should start to attract interest.
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