It’s the beginning of the end of easy money from Latin America, Merrill Lynch says

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The beginning of the end of easy money means investors should avoid duration and currency risk in Latin America, LatAm fixed income strategists at Merrill Lynch Claudio Irigoyen and Ezequiel Aguirre say.

“But once the post-FOMC (Federal Open Market Committee) dust settles, we see several attractive short-end rates trading opportunities based on local monetary policy outlooks.

We favour the following trades. In Brazil, receive Jan14 CDI future rates since more than 200bp in rate hikes are priced by year-end. In Mexico, receive 2y TIIE rates since about 100bp in rate hikes are priced in the next 24m. In Colombia, receive 1y COP/IBR rates since 125bp of rate hikes are priced in for the next 12m. In Chile, pay 6m CLPxCAM rates since 50bp in rate cuts are priced in by year-end.

Stick to monetary policy fundamentals

The FOMC made no changes to its policy language, but made an important change to the outlook, noting that it now sees downside risks as ‘diminished.’ The Federal Reserve presented a more optimistic set of forecasts that suggest tapering could start this year.

This was a decisively hawkish FOMC meeting.

We expect currencies and interest rates in Latin America to trade with a bearish bias – weaker currencies, higher and steeper curves – and high volatility in the near term. The era of ultra-low US rates is coming to an end. The immediate risk to emerging markets is for outflows. In this environment, we avoid taking duration and currency risk against the US dollar. Once the dust settles, we recommend focusing on the following short-term monetary-policy-based strategies.”

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