Currency Carry Trade Outlook for INR, IDR, PEN/CLP and Other Emerging Markets

At this juncture, the Indian rupee seems to be the only one in the region that is expected to display a much lower sensitivity to US rates, outperforming others within Asia. We expect the Monetary Authority of Singapore to keep the SGD NEER in the weaker side of the band for the next few months, which reduces the downside risk for the trade (Chart 69). We like the INR as the preferred long, followed by the IDR, as they offer high risk-adjusted carry, central banks are interested in keeping their currencies stable, current account deficits are bounded, and the currencies are not expensive relative to long term fundamentals. The main risk of the trade is of higher oil prices, and considerable reversal of capital flows. Apart from that, a change in the behavior of Reserve Bank of India it terms of managing INR to accumulate international reserves is also a risk. LatAm: long PEN/CLP We like long PEN/CLP (spot 195.7, target 200, stop 195.5). LatAm is the most exposed region within EM to global factors. Traditional carry trade candidates like the Brazilian real and the Argentina peso are no longer attractive given the still fragile fiscal stance in both countries. Local positioning in BRL has proven to be heavier than thought, and we expect the currency to continue weakening until we observe some stabilization in US rates. The Brazilian real is still overvalued and the economy will be negatively affected since its strategy to gradually reduce budget deficits is based on low global rates, capital inflows and higher domestic growth. In the case of the Argentine peso, despite showing some detachment from global factors and some positive inflows due to the tax amnesty, we think the currency needs to weaken given the recent depreciation of the BRL and its current overvaluation as well as the government fiscal needs for 2017, which is an important electoral year. Therefore, we remain neutral on these currencies. A more modest but more interesting carry trade within LatAm in an environment of higher US rates is to be long the Peruvian sol, funded with the Chilean peso, in order to make the trade more neutral to commodity exposure. The Peruvian economy is expected to continue growing at rates above 4% due to strong mining activity; the new government will likely implement expansionary fiscal policy and has room to finance it. The exchange rate is close to its equilibrium value based on terms-of-trade and productivity. In fact, we expect the currency to appreciate in real terms if growth recovers as predicted. The currency still offers a decent carry. We forecast a nominal depreciation but below the forward. The central bank has a strong preference for low currency volatility and would be ready to intervene in case of a disorderly depreciation, as it has been already the case in the last few days with small interventions in the forward market. On the other hand, Chile’s growth remains anemic and the economy is expected to continue growing sub 2% in 2017 (Chart 71). The CLP is overvalued but recent flows Chart 70: Copper prices are a major risk factor Chart 71: Relative growth to favor Peru going forward 400 230 ——pen/clp growth diff (rhs) 5 220 4 350 210 3 300 200 2 190 | 950 180 0 =———= Copper prices 170 200 + — CLP (ths, Jan2012 =100) {60 - 150 150 een PEN (ths lanatl2 =100) 2010 2011 + 2012»««-2013-S-2014-=S 20152016 2012 2013 2014 2015 2016 Source: BofA Merrill Lynch Global Research, Bloomberg, Haver Source: BofA Merrill Lynch Global Research, Bloomberg 40 Global Rates, FX & EM 2017 Year Ahead | 16 November 2016 Bankof America Merrill Lynch HOUSE_OVERSIGHT_014770