Fixed Income and Currency Strategist

Gautam Jain, PhD, CFA

FX & Rates

<ul>
<li>Brazil's rate curve has gone through significant transformations in the past few months, with the curve currently exhibiting a hump in the front end and a kink 3 years out.</li>
<li>The driver behind the hump has been the aggressive rate hikes and the kink is resulting from increasing risk premium in the long end arising from fiscal and election uncertainty.</li>
<li>I expect the kink to get pronounced as more rate cuts get priced with inflation coming off the peak and growth slowing, while risk premium increases heading into the election.</li>
</ul>


Brazil's rate curve has gone through significant transformations in the past few months, with the curve currently exhibiting a hump in the front end and a kink 3 years out.
The driver behind the hump has been the aggressive rate hikes and the kink is resulting from increasing risk premium in the long end arising from fiscal and election uncertainty.
I expect the kink to get pronounced as more rate cuts get priced with inflation coming off the peak and growth slowing, while risk premium increases heading into the election.


A Hump and a Kink in Brazil’s Yield Curve

<ul>
<li>With the volatility of US rates remaining elevated, it is a good time to evaluate how my thematic recommendation for 2022 of curve steepening trades in EM is playing out.</li>
<li>The slopes of rate curves in EM have stabilized even as they continue to flatten in the US and, more broadly, DM – a break in correlation that should persist.</li>
<li>EM curves should start steepening as ex-Asia they are ahead of DM in rate-hiking cycles and their worsening debt dynamics should keep the risk premium elevated in the long end.</li>
</ul>


With the volatility of US rates remaining elevated, it is a good time to evaluate how my thematic recommendation for 2022 of curve steepening trades in EM is playing out.
The slopes of rate curves in EM have stabilized even as they continue to flatten in the US and, more broadly, DM – a break in correlation that should persist.
EM curves should start steepening as ex-Asia they are ahead of DM in rate-hiking cycles and their worsening debt dynamics should keep the risk premium elevated in the long end.


An Update on High Conviction 2022 Thematic Rate Curve Steepening Trades in EM

<ul>
<li>While EM rates on aggregate have moved up as US rates have risen, there is a fair degree of differentiation within EM; e.g., the divergence between India and Mexico.</li>
<li>Rates in India climbed higher following the pro-growth budget, which increased borrowing needs, while yields rallied in Mexico following indications that the country has entered a technical recession.</li>
<li>These idiosyncratic developments accelerated the divergence in rates between the two countries, allowing me to suggest taking profits on my Receive Mexico 5y vs Pay India 5y rate trade recommendation.</li>
</ul>


While EM rates on aggregate have moved up as US rates have risen, there is a fair degree of differentiation within EM; e.g., the divergence between India and Mexico.
Rates in India climbed higher following the pro-growth budget, which increased borrowing needs, while yields rallied in Mexico following indications that the country has entered a technical recession.
These idiosyncratic developments accelerated the divergence in rates between the two countries, allowing me to suggest taking profits on my Receive Mexico 5y vs Pay India 5y rate trade recommendation.


Alpha Bites: Take Profits on Recommendation as Rates Move in Opposite Directions in India and Mexico

<ul>
<li>In the current environment of upside risks to global rates, it is appropriate to look for countries where one can position for rates to move higher with limited downside.</li>
<li>From this perspective, I like shorting long-end rates in Colombia ahead of the upcoming presidential election in May where a leftist candidate is leading in the polls.</li>
<li>The political risk premium should rise in Colombia using the increase in rates in Peru and Chile last year as guidance since both countries went through similar election-related political turmoil.</li>
</ul>


In the current environment of upside risks to global rates, it is appropriate to look for countries where one can position for rates to move higher with limited downside.
From this perspective, I like shorting long-end rates in Colombia ahead of the upcoming presidential election in May where a leftist candidate is leading in the polls.
The political risk premium should rise in Colombia using the increase in rates in Peru and Chile last year as guidance since both countries went through similar election-related political turmoil.


In an Environment of Rising Rates, Colombia 10y Local Rate Is a Good Short

<ul>
<li>The risk of US yields continuing to rise is high especially with inflation not having peaked yet, the Fed potentially reducing its balance sheet, and real rates still negative.</li>
<li>The high volatility in US rates does not bode well for EM rates due to their high correlation even though EM local debt is overall cheap based on most metrics.</li>
<li>Until the volatility in US rates subsides, it is best to focus on cross-country and curve trades in EM, with my preference for curve steepening trades in several countries.</li>
</ul>


The risk of US yields continuing to rise is high especially with inflation not having peaked yet, the Fed potentially reducing its balance sheet, and real rates still negative.
The high volatility in US rates does not bode well for EM rates due to their high correlation even though EM local debt is overall cheap based on most metrics.
Until the volatility in US rates subsides, it is best to focus on cross-country and curve trades in EM, with my preference for curve steepening trades in several countries.


What to Expect of EM Rates When Expecting US Rates to Stay Volatile?

Poland

A vanila interest rate swap us an agreement between two counterparties to exchange cashflows (fixed vs floating) in the same currency. This agreement is often used by counterparties to change their fixed cashflows to floating or vice versa. The payments are made during the life of the swap in the frequency that is pre-established by the counterparties.

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PLN 10Y (PZSW10 CURNCY)

A Hump and a Kink in Brazil’s Yield Curve

I expect the hump and kink in Brazil's curve to get more pronounced as more rate cuts and a higher risk premium is priced, which should lead to a...

Gautam Jain, PhD, CFA

An Update on High Conviction 2022 Thematic Rate Curve Steepening Trades in EM

Revisiting my thematic recommendation for 2022, EM rate curves should start steepening as ex-Asia they are ahead of DM in rate-hiking cycles and...

Gautam Jain, PhD, CFA

Alpha Bites: Take Profits on Recommendation as Rates Move in Opposite Directions in India and Mexico

Idiosyncratic developments accelerated the divergence in rates between Mexico and India, allowing me to suggest taking profits on Receive Mexico 5y...

Gautam Jain, PhD, CFA

In an Environment of Rising Rates, Colombia 10y Local Rate Is a Good Short

I like paying Colombia 10y as the political risk premium should increase going into the presidential election in May based on similar episodes in...

Gautam Jain, PhD, CFA

What to Expect of EM Rates When Expecting US Rates to Stay Volatile?

The high volatility in US rates does not bode well for EM rates due to their high correlation even though EM local debt is overall cheap. Cross...

Gautam Jain, PhD, CFA

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