Wednesday, December 03, 2008
One of Macro Man's favourite themes at the moment is the necessity and likelihood of EM policy easing in response to the global recession and disinflationary/deflationary dynamic. For sure, most EM countries have eased policy to one degree or another- some of them aggressively. But a few EM CBs have stuck to their guns....for now. Therein lies opportunity. One of the best out there at the moment is Brazil.
The land of the Amazon has been a favourite target of macro punters for much of the past three years or so. Until the third quarter of this year, most of that focus was in the equity and especially the currency markets. There was little not to love about the BRL- where else could you get a currency with double-digit nominal rates, high single-digit real rates, and a current account surplus/commodity tailwind to boot?
Macro Man took a look at the BRL more than a year and a half ago and concluded (erroneously) that there was relatively little opportunity left in the currency. How wrong he was, as USD/BRL tumbled 25% in the ensuing 15 months.
Since then, of course, USD/BRL has subsequently rallied more than 50%. Was this justified? According to Macro Man's metrics, no. His favoured measure of real fair value, a terms-of-trade adjusted PPP measure, has suggested that the equilibrium level of USD/BRL has risen somewhat...but nowhere near the amount of the recent spot rally. That, Macro Man would suggest, has much more to do positioning. Sure, there were some stale foreign longs in BRL, but those surely threw in the towel by 2.00. The real story (if you'll pardon the pun) is the toxic positioning in the Brazilian corporate sector, which drove spot aggressively higher and some companies to the brink of bankruptcy. Today, onshore punters are long dollars to the tune of $13 billion, according to data from the BM&F.
While short USD/BRL will (eventually) be a nice global recovery trade, the time for it could easily be eighteen months away. No, for the time being he prefers the fixed income market, where slowing activity and a levelling off of inflation pressures have been reflected in yields with...err..exuberance.
Since the middle of November, yields across the curve have fallen more than 2% in some buckets, a very sizeable rally. The front few contracts are trading close to flat with the SELIC rate, but none are yet pricing in a cut. With industrial production virtually stagnant on a y/y basis now and indicators of global activity plumbing new depths seemingly daily, in Macro Man's view it's only a matter of time before the BCB sees the light and cuts.
That having been said, it's difficult to add/establish after a 200 bp rally, with much of it coming in thin trading conditions. It wouldn't altogether surprise to see a 50bp-plus pullback in the Jan 10- Jan 12 part of the curve.
If any sort of priced hiking is re-introduced, however, it looks like a nice opportunity. What's been especially gratifying about this trade recently is that it has exhibited zero correlation with the SPX.
Traditionally, EM fixed income trades more like a stock than a bond, rallying and falling with risk aversion. Some time last month, however, the DIs (exchange traded swaps) seemed to decide that they are, in fact, bonds, and the traditionally negative correlation between yield changes and changes in the SPX vanished.
This has made it an especially attractive trade, as it has escaped from the "risk on/risk off" mentality that has assailed most other assets in one way or another. Speaking to other macro punters recently, Macro Man has to accept that he is hardly alone in this view. But the crowd, as they say, can't always be wrong...and this is a case where fundamentals, current pricing, and thematic relevance make it one of Macro Man's favourites in an environment where equities seem to run around like a headless chicken.