Improved risk appetite has resulted in an appreciating bias for LATAM assets over the past couple of months, but that momentum appears to be waning now, with valuations in some assets looking somewhat less attractive (eg, CLP).
Even though a truce in “trade-war” concerns and a less hawkish US Fed would be supportive of investor sentiment towards EM assets, some local assets may struggle to appreciate substantially from current levels.
Argentinean assets are perhaps the highlight in the region, still offering attractive valuations and significant potential to benefit from a relatively benign external environment. In fact, Argentina appears to have again become the destination of choice for foreign investors with appetite for risk. High volatility means that the currency frequently fluctuates between best and worst in the region, but the high carry should keep investor interest in the nearer term. We still expect ARS assets to suffer from the political uncertainty generated by the upcoming Presidential election, but election-related risk premium should be incorporated into prices closer to May-June. Until then, external drivers should play a bigger role and likely lend an appreciating bias for local asset prices.
The “glass half-full” perspective is likely to prevail for the Mexican peso as well. In this case, the attractive carry and the solid macro fundamentals should compensate for policy uncertainties ranging from the highly uncertain and systemically important outlook for PEMEX and the outlook for monetary policy under the new administration.
Regarding the Brazilian real, we remain highly sceptical that the social security reform will follow a smooth approval process in Congress. Our concerns were exacerbated in recent days, with the confirmation that the Lower House will not allow the reform to be fast-tracked, skipping some of the procedural steps that the reform advanced by the previous administration had already gone through. The Bolsonaro administration was able to elect allies to preside in both legislative chambers, but the effective size of its support-base remains unclear. Overall, we expect uncertainty about reform passage to create episodes of volatility in the coming months, leading the BRL to test levels closer to 4.0, before the proposal is finally approved by the Lower House. Congressional leaders are indicating that the reform may be approved by mid-2Q, but our base-case scenario is for a later-than-expected approval, possibly in early 3Q.