Going LATAM

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Bipan Rai: Welcome everyone to another edition of The FX Factor podcast. This is number five in our series, which is available on all the major podcast platforms, including Apple, Spotify and on Google. For today’s episode will be taking a different approach this time around and talking about Latin America. And I figured, who better to have on then our LATAM strategist and really our resident expert on Latin America here at CIBC, Luis Hurtado. Luis, how are you, sir?

Luis Hurtado: Good morning Bipan, and thank you for the invite.

Luis Hurtado: Not a problem. The big question du jour for your region, I guess you could say it’s not really du jour, its for pretty much every year we talk. What on earth is going on with Brazilian politics right now, Luis?

Luis Hurtado: Well, we could write a couple of books on it, and I still run out of space. But mostly the current political situation has three main factors at play. The structural reforms, the pandemic and the return of Lula. I mean, just to give you a brief background, at the end of 2019 and the start of last year, the market was excited about the prospects of three reforms: administrative, fiscal and a tax reform. Nevertheless, the pandemic hit and all of them were put on hold. As the covid-19 pandemic developed, the government implemented an aggressive fiscal expansion programme, while the president continued to minimise the effect of the health crisis. This led to a first round of speculation about the departure of the economic tin. A Topic that will remain present until now. And the president implemented some cabinet changes around June last year. At this point, President Bolsonaro managed to secure the support of centrist parties, which plays an important role going forward, and that of the economic team ensuring the market that their spending cap will be respected going forward and the triggers where we’re going to be put in place to limit further expenditures.

Bipan Rai: So basically, it’s a question of whether or not the economic team is going to remain on board with, I guess, this upcoming cabinet shuffle. Am I hearing that right?

Luis Hurtado: Yes. I mean, all of this change starting in 2021,Bolsonaro decided to fire the Petrobras CEO on disputes, on gasoline prices. Then budget discussions started and there were increasing pressure to leave some government assistance programme out of the spending cap. Then once again, the economic team departure and fears resurface. And finally, the return of Lula to the political arena as a top court judge and all his previous convictions. This allows him to run into the next year’s election. I mean, the consequences of this are huge for President Bolsonaro. First, it creates further uncertainties on the approval of the tax and administrative reforms this year, and it pushes the president to implement more populist measures to secure the support of centrist parties into next year.

Bipan Rai: Right. So, I mean, is there a genuine chance Lula will be re-elected to the presidency? Is that something that a lot of prognosticators onshore in Brazil expect to happen?

Luis Hurtado: Politically, we have already seen some changes kind of to come and ensure the support of the centrist parties. The president, dismiss the navy, army and airforce commanders last week. And we are also seeing an increasing pressure to implement a new round of fiscal support regarding the Lula’s prospects, he hasn’t yet confirmed his candidacy, but the current economic and social situation of the country will certainly make him a strong option. I mean, recent polls suggest that he will tie Bolsonaro in a first round election with 29 percent and 28 percent of the vote, respectively.

Bipan Rai: So what does this mean for Brazilian assets and potentially and in particular what the BCB might do going forward?

Luis Hurtado: On this point, we expect Dollar Reale to retest the 580 mark. I’m off to the all time highs. That’s 597 on any signs of a possible departure of the economic team, especially Finance Minister Geddis. On the down side for Dollar Reale. We do not see enough support for a sustained brake below 550 until we see progress on the administrative and tax reforms and some discrepancies with the 2021 budget.

Bipan Rai: Now, if you had to pick a side, I mean, would you say that Dollar Reale risks are higher? I guess that’s an indirect way of saying, Do you think that this risk of potentially Getti’s leaving the capital is probably the more likely risk in the short term?

Luis Hurtado: Yes, we need to finish the discussions on the reforms and the 2021 budget discrepancies first.

Bipan Rai: OK, excellent. Now, with that in mind, then, if that is the case, then do you see any sort of increased risk of interventions in the reale from the central bank?

Luis Hurtado: Yeah, there are a couple of points. The central bank has already adopted a very hawkish stance increase in 75 basis points, the selling rate in the last meeting and signalling a similar and increasing in May. We have revised our year end selling rate forecast from 450 to 550. On the interventions in the market, the central bank has taken a step back from the interventions we saw mid-March. However, we expect the central bank to assume this trend on a spikes up of 580.

Bipan Rai: OK, that’s good information. Switching gears a bit now to Mexico. What’s the key political story there to pay attention to for our listeners?

Luis Hurtado: Key political story will be the approach of that June midterm elections in Congress. The official campaign started this week and expect the ruling coalition to maintain the 50 percent of their seats in Congress, however, this also is likely to increase support for a more populist approach by the government. I mean, increasing concerns and further changes to the energy sector, for example.

Bipan Rai: Yeah. So speaking of the energy sector, then, I mean, can you tell us a bit about Pemex and whether or not government support to Pemex is going to matter, especially on the credit rating side?

Luis Hurtado: Of course. I mean, the government is already providing a significant support to Pemex via tax breaks and cash injections. We expect this to be the case going forward on this note. I mean, for example, the government has already stated they will inject eight point five billion to Pemex this year. That created implications for this are significant. I mean, Mexico continues to indirectly buy the company’s debt, which has already drained the country’s emergency funds and continues to limit the government’s fiscal response to the pandemic. OK, excellent. Any of this impact Bahico potentially down the road?

Luis Hurtado: Indirectly, yes. They support the continuation of accommodative stance for the remainder of twenty one. Remember that Mexico is the only country in the region that did not provide a significant fiscal expansion programme to battle the pandemic. This resulted in at close to 10 percent decline in growth last year. Having said that, I mean, the market has rushed to price an aggressive hiking cycle for the next year, 100 basis points following the end of the easing cycle signalled by Markico last month. We do not expect this to be the case as a board of directors support a more neutral stance for the rest of the year.

Bipan Rai: OK, and for the Mexican peso and other Mexican assets for this year, what are you expecting in general?

Luis Hurtado: For the peso with regard to Dollar Mex, we expect to resume its upward trend towards the 2150 mark as fiscal and political issues resurface, while the reflation trade continues to support higher USG also and Bahico remains for most of 21 on hold.

Bipan Rai: For our listeners, we should specify that currently Dollar Mex is trading at twenty point one six just because, you know, things can move around a little bit with respect to EMS, as I’m sure most people are aware.

Luis Hurtado: With regards to the market and in line with our call, we see space for some steepening of the curve as respect Bahico to disimpoint, those expecting 100 basis points and rate hikes in the next 12 months.

Bipan Rai: OK, switching gears again a little bit to another country in Latin America with respect to Peru, there are elections this week. Is there anything that you would flag for investors that they should be watching there?

Luis Hurtado: Yes, it is an interesting election. The latest poll reported five candidates tied in first position, three of them being market friendly, one neutral, and a leftist candidate that could put pressure on the soul and the sovereign curve. I mean, historically, that tends to be a two week period of excessive volatility. When I left party candidate manages to move into the second run election. This could certainly be the case this week. I will take a neutral stance regarding the Sole and in the fixed income markets as we get the results from the election.

Bipan Rai: OK, interesting. We’ll definitely keep an eye on that. And for any comments that you might have with respect to the election, any other themes that you’re monitoring and some of the other countries you cover, including Chile and Colombia?

Luis Hurtado: Well, in Chile, we have the constitutional assembly election next month. We continue to see a greater representation of the centre left and leftist political parties in the constitutional assembly, but not enough to secure the two thirds of the seats needed to implement significant changes in the new constitution. In Colombia, It’s mostly about the government’s proposal for fiscal reform, especially tax increases. The government is expecting to get another one point five percent of GDP in revenues into 2022. However, this is likely to face some opposition from Congress. That’s one of the ideas, is to increase the value added tax to the basic food basket.

Bipan Rai: Right. And do you see any sort of implications from broader commodity themes to either of those currencies?

Luis Hurtado: We have seen Dollar Chile, at the 700 mark last month. In Colombia, we have not seen that positive support the Colombian peso from the increase in oil prices. And most of this response to the fiscal situation, I mean, there are concerns that Colombia could lose its investment grade rating.

Bipan Rai: OK, and so now is my chance to put your feet to the fire. Which LATAM and currency are the most bullish on, and which ones are you the most bearish on? I mean, most bearish in the short term, obviously, is the reale. There are many political and fiscal factors at play that we see very difficult to have an end with the return of Lula. Also, you have to add the volatility and it’s not a good candidate for short term positions on either side of the reale. In terms for the most bullish, we are the most bullish in the Chilean peso. However, we will wait for a bit of a spike towards the 740 mark for the largely on just the normal noise around elections.

Bipan Rai: I guess we’ve covered everything I wanted to talk about for this podcast. Thank you so very much, Luis Hurtado, for joining us for this edition of The FX Factor podcast. Again, don’t forget to click subscribe on either Spotify, Apple, iTunes or on Google and we’ll talk to you next time. Thank you for joining us.

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