Central banks across Latin America are about to lead the world toward a wave of easier monetary policy. Traders, it seems, are paying the price as they wait.
(Bloomberg) — Central banks across Latin America are about to lead the world toward a wave of easier monetary policy. Traders, it seems, are paying the price as they wait.
Investors in the region’s interest-rate swaps market — which uses bond derivatives to bet on central bank policy moves — have been pricing in pivots from Brazil and Chile for months, profiting along the way.
But now, as those interest-rate cuts slowly edge closer to reality, traders who used the swaps curve’s short end to position are getting stuck with maturing contracts and high costs of re-entry — not to mention the risk that policymakers cut rates more slowly than expected.
“Too many people have been pricing too many rate cuts,” said Hari Hariharan, the chief investment officer at NWI Management in New York. “These trades are not going to work if central banks stay high for long.”
Chile, where policymakers are expected to kick off an easing cycle on Friday, offers a prime example. Money managers have already priced in roughly 640 basis points of rate cuts using swaps contracts in the coming year — even though inflation in the nation still runs above 7%, double the central bank’s target.
Money managers from around the world have honed in on Latin America this year in anticipation of dovish shifts by domestic central banks. Policymakers in emerging markets were generally faster to embark on hiking cycles to combat inflation than their peers in major economies, which is seen as allowing them to move more quickly toward cuts. But the precise timing has been hard for traders to pinpoint.
The wait, at least, seems to be over. Uruguayan authorities have already started lowering rates, with Chile widely expected to do the same later this week. Brazil, where for months traders have been pricing in an easing cycle starting in the first quarter, will likely follow suit.
Central bank chief Roberto Campos Neto and his colleagues are expected to lower the so-called Selic rate between 25 and 50 basis points basis points at their meeting next week, according to swaps traders. Investors have already priced in 460 basis points of easing in this cycle — a move that would lower the key borrowing rate to near 9% from its current of 13.75% by the end of 2024.
In Colombia, meantime, investor bets implied interest rates will be almost 400 basis points lower over the next year. While annual inflation in the nation slowed in June as food price rises eased, it remained above 12%. Economists surveyed by the local central bank forecast that policymakers will start lowering borrowing costs in October.
Given how much traders have already been priced in, the recent rallies in local rates are likely to be limited unless a shocking resurgence in inflation hits Latin America, said Jens Nystedt, a senior portfolio manager at EMSO Asset Management.
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