LatAm FX: Higher volatility exposes carry risks – BNY

G10 rates are edging higher. As realised volatility surges, BNY’s Geoff Yu flags increasing vulnerability in Latin American FX carry trades. Real rate gains must come from policy, with Brazil’s and Mexico’s central banks expected to keep rates unchanged and no support from the terms of trade. Positioning data point to selling pressure in COP and CLP. BRL, meanwhile, requires a sustained revival in buying momentum.

Latin American high-yielders: risks build

"Real rates aren’t making headway. The central banks of Brazil and Mexico announce policy decisions this week, and neither is expected to move."

"By contrast, the risk to G10 rates, including for the EUR and USD, remains to the upside, eroding carry compensation as volatility rises. The biggest frustration for Latin America may be the lack of a clear terms-of-trade lift this year despite evident supply constraints. That leaves central banks, which are reluctant to tighten, to deliver the real rate gains needed to keep policy restrictive."

"Latin American holdings are a positioning challenge. Our data show that holdings of high-yielders are generally light, but Latin American currencies face risks. COP and CLP are being sold (or hedges are rising) from heavily overheld positions, while attempts to build MXN longs are losing steam."

"BRL and PEN are underheld, though only BRL shows weak buying momentum – a clear turnaround in profitability is needed to push holdings back into positive territory."

"Value is opening up in high-carry names. The Brazilian election was always going to be the key risk event for Latin America and high-carry names. The market has materially repriced its expectations, and the region’s political environment should settle into year-end and early next year."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)