Wednesday, February 3, 2010

Latin America FX Strategy Update

Reduce Exposure to Short CLP/COP

•We recommend taking profit/reducing exposure to short CLP/COP
positions, as the cross has broken down in the last two weeks.

•The med Though the medium-term rationale in favour of COP remains intact, we recommend
taking profit/reducing exposure on short CLP, long COP positions on a tactical basis
due to the rapid convergence to below our target of 3.71.

The CLP/COP cross collapsed from 3.975 on January 19 to 3.700 currently – a move of close to 7% in just 10 trading days.

Our preference for being long COP versus regional peers, namely the CLP, was based
on a more bullish view on the Colombian economy than what is currently held by the
market, which we believed would lead to an outperformance of the COP as it caught
up to other currencies in the region.

We had selected the CLP as the funding currency due both to the low rate environment in Chile, but also due to the CLP’s relative outperformance over the last six months. Likewise, the fact that the market had already seemed to be pricing a positive outlook on Chile’s economy increased the potential for negative surprises, in our view. Indeed, the release of weak industrial production figures in Chile on January 28 (-0.3% versus an expected +1.2% yoy) illustrates our point.

Colombian economic data, on the other hand, is currently more susceptible to upward revisions, in our view. (Please see EM Strategy Update: Re-pricing Growth in Colombia, January 21, 2010, for more detail.) We still believe that this relative dynamic will play itself out in coming weeks. But the rapid moves sparked by an unexpected change in Chilean pension fund (AFP) hedging
guidelines set forth by the country’s financial regulator last week further informs our
decision to pare back exposure at this juncture.1 Uncertainty about the interpretation and longer-term impact of the new guidelines makes us more sensitive to the potential of a rebound in the CLP.

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