LatAm FX: Carry exposed as volatility rises – BNY
Geoff Yu at BNY highlights growing vulnerability in Latin American FX carry trades as realized volatility spikes and G10 rates drift higher. With Brazilian and Mexican central banks seen on hold and terms-of-trade support lacking, real rate gains must come from policy.
BNY analyst Geoff Yu identifies heightened vulnerability in Latin American FX carry trades due to rising volatility and G10 rates. While Brazilian and Mexican central banks remain on hold, terms-of-trade support is lacking, necessitating real rate gains from policy. Positioning data reveals selling pressure in COP and CLP, with BRL needing a sustained recovery in buying momentum.
Real rates show no significant progress, and central banks in Brazil and Mexico are expected to maintain current policies, neither signaling a move. Meanwhile, risks to G10 rates, including EUR and USD, remain upward, eroding carry compensation as volatility rises. The primary concern for Latin America is the absence of a clear terms-of-trade boost this year, despite evident supply constraints.
This leaves central banks reliant on delivering real rate gains to sustain restrictive policies. Latin American holdings present a challenging positioning landscape, with relatively low exposure to high-yielding currencies. COP and CLP are heavily overheld positions, with selling pressure or increased hedges, while MXN longs are losing momentum.
BRL and PEN are underheld, but only BRL shows weak buying momentum, requiring a turnaround in profitability to bring holdings back to positive territory. Value emerges in high-carry names, with the Brazilian election serving as a key risk event. Market expectations have been re-priced, and political stability should prevail by year-end and early next year.
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