Emerging Markets | FX | LATAM | Rates
Our Themes And Trade Idea Update: Most of Our Trades Post Gains
- By Bilal Hafeez
- 2 min read
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We continue to hold our trades. Almost all gained on the week – most notably our short rates trade which swung to a +1.4% gain from -0.5%. Here are the details of the trades:
- Rising yields: short rates (US real 5y, Ger 10y, Jpn 30y futures). Big jump in yields, especially in bunds, over the past week, which saw this position gain 2% on the week.
- Premise: Rhetoric from the Fed appears to be leaning towards 50bps hikes per FOMC meeting, but terminal rate pricing still appears too low. This could see bond yields continue to move higher. The risks are similar with ECB. In Japan’s case, there is more inflationary pressures which could affect the long-end.
- Lower equity markets: short equities (S&P500, Eurostoxx, 50% of notional). The stocks bounce appears to have run out of it steam, which has helped our trade, which gained 0.4% on the week.
- Premise: Fed likely to tighten even if growth slows, global economic slowdown, equity valuations pressured by higher bond yields.
- Higher energy prices: long oil (brent, 25% of notional)Oil continues to march higher, which saw this trade gain 0.8% on the week.
- Premise: there is a structural supply-demand imbalance in oil markets. Inventory levels are running low. The US’s SPR release appears to be priced now and risks of European sanctions on Russia energy are growing.
- LATAM FX bounce: short USD/LATAM (short USD/BRL, short USD/CLP). Mixed performance with short USD/CLP gaining 0.9% on the week, while short USD/BRL lost 0.4%.
- Premise: As the dollar starts to weaken and the China outlook stabilizes, we look for the best EMFX longs. We focus on the strong commodity performers of Q1, whose rally was cut short when USD/CNY spiked in April. Positioning in LATAM FX is now somewhat cleaner than in Q1, while carry and terms of trade are still attractive. BRL and CLP are the best LATAM longs when we compare valuations, ToT, carry, positioning and the political outlook.
- Divergent EM policy: receive Mex 5y, pay India 5y (long MXN 5y swaps, short INR 5y swaps). The spread moved against us over the past week.
- Premise: India and Mexico have similar inflation levels (~7.70%). But their policy rates are vastly different: the RBI rate is 260bp below Banxico’s. Banxico is more or less ‘on track’ with its monetary policy. RBI is ‘behind the curve’, similar to the case in India in 2011. India should step up its rate hikes relative to Mexico. Dynamics in the fiscal deficit and GDP growth also suggest to pay India vs receive Mexico.
- North Asia weakness: short North Asia (short CNY basket, long INR/TWD). Our short CNY basket gave back gains on the week and is in the red now. Our long INR/WTD trade gained 1%.
- Premise: With the China economy slowing down on the back of its zero-Covid policy, the PBoC is using currency devaluation as a tool for economic support. TWD will weaken as its correlation to CNH is high and its valuation is still reasonably expensive. India could gain from being an insular economy and having a proactive central bank that intervenes to keep the currency from weakening.
In terms of performance, our portfolio gained 0.5% on the week. Since inception in 2020, it is up an annualised 13% with a Sharpe ratio of 1.9 (Chart 1, Table 2). Our largest risk positions (VaR) are in FX, followed by equities and commodities (Chart 2). The P&L are paper returns, so are likely overstated compared to a real invested portfolio.
