Rates 10y Dashboard: Chile’s Curve Steepens Even as US Curve Flattens

The US long-end yields continue to trade in a narrow range while it awaits new data as the next catalysts. Although the US 10y yield was flat for the day, EM 10y rates sold off 4 bp on average. Rates in most EM countries were wider with the biggest movers being Turkey 10y (TRY 10y), Brazil 10y (BRL 10y), and Russia 10y (RUB 10y).

In Turkey, the rates market remains volatile even though the new governor left rates unchanged at the MPC meeting last week. However, the central bank removed a reference to tighten if needed, an indication of the return to unorthodox policies.

In Brazil, the government reached an agreement with Congress to not include Covid-related spending in the 2021 fiscal targets. This is positive for growth and the currency at least in the short term, but increases fiscal risks, hurting the long end of the curve.

In Russia, while the post-sanction reaction should have been positive, the build-up of the Russian military along the Ukrainian border is raising concerns.

Beyond these outliers, the reaction of EM curves to the US curve flattening this month, after the relentless steepening since the start of the year, has been relatively muted. One of the countries moving in the opposite direction is Chile.

The chart below shows that as the US curve has flattened, Chile’s curve has steepened. The correlation between the two curves was quite strong up until late 2019 when the risk premia in the long end of Chile’s curve started building up on the back of local protests, which eventually led to the agreement for rewriting the constitution.

Before the risk premium could come down, the pandemic arrived which led to a further increase. With the risk premium staying high when US rates started climbing higher this year, the long end of Chile also moved higher but with a lower beta.

This month, however, the correlation has turned negative as Chile’s 10y rate (CLP 10y) has moved higher and in the opposite direction to the US. The proximate reason is the lower house approved a third round of pension withdrawals in a landslide despite President Sebastián Piñera pushing against it.

The curve steepening in Chile is not yet an opportunity as there are a couple of opposing forces at play:

• After USD 34bn of withdrawals in the first two rounds, withdrawals in the third round are expected to be limited at less than USD 10bn. Moreover, Chile’s rapid pace of vaccinations places it in third place in the world. Although the efficacy of the Chinese vaccine, which is the primary one being used in Chile, is lower than other vaccines, it sets up the country on the path to a strong economic rebound, putting pressure on the short end for rate hikes.
• However, while the curve is pricing in a rate hike within 6 months, we expect the central bank to delay hiking rates due to the pandemic-related economic uncertainty. Indeed, the most recent survey by the central bank concurs as those surveyed expect rates to remain steady for at least another 6 months.

In the near term, we expect the factors leading to steepening to dominate. However, we need to track the curve steepening as it could become an attractive opportunity if the risk premium in the long end gets overdone.

Data Source: Refinitiv

Best Longs / Best Shorts

• Our lists of underperformers and outperformers in the attached Rates 10y Dashboard pdf stayed unchanged.
• On the list of underperformers we have Peru 10y (PEN 10y) and Poland 10y (PLN 10y).
• Our list of outperformers stayed empty.

Best Crosses

• Our list of preferred relative-value trades has changed slightly to Receive PEN 10y vs Pay Indonesia 10y (IDR 10y) or Taiwan 10y (TWD 10y) or South Africa 10y (ZAR 10y).
• The 3m expected returns for the pairs are in the range of 7.5-8.0% (not annualized), assuming mean reversion.