October 12, 2016

Global Macro Strategy

STRATEGY UPDATE—Some Thoughts On Our Fall IMF Meetings

During this past weekend XP Securities hosted a series of high-level meetings in Alberto J. Bernal
Washington DC with clients and senior public officials (Ministers, Vice-Ministers, Chief Global & EM
Central Bank Presidents and Central Bank Board Members), with Senior Strategist
Officials from International Financial Institutions (IFIs), Rating Agency Directors, +1 (786) 725-5984
and with a variety of economic and political consultants –see this link for a +1 (917) 488-0946

copy of our final agenda. The themes discussed during our program included
(1) the health of the world and the US economies, (2) the possible outcomes
of the ongoing US election cycle, (3) the expected performance of the
Mexican economy and the perspectives for monetary policy, (4) the current
performance of the Colombian economy and its rating outlook, (5) the likely
future path of Brazil monetary and fiscal policy, (6) the possible future path of
Argentina sovereign ratings, (7) the likely future growth performance of China,
and (8) a variety of other market-relevant issues.

To start, let us say that we found the mood in DC to be quite somber. Investors
and policy makers appear restless with lingering low economic growth rates
and the subsequent need to a maintain policy very close to the zero-bound. It
is quite clear that flat yield curves and intervention rates remaining in
negative territory or very close to 0% make the life of investors that are
restricted to high-grade investments, a very complicated one. The problem,
however, is that, at least in our view, the only alternative to keeping rates this
low and policy so expansionary, is structural reform and increased fiscal
expenditures, or else, deflation.
The current evidence shows, however, that world-wide voters are simply not
interested in hearing about welfare-enhancing reforms (structural tax reform,
further opening up of the economy, second generation labor and pension
reforms) at this time. If they were, they would not be voting in favor of
implementing a protectionist and anti-immigration policy agenda. Therefore,
it appears to us that monetary policy will remain the only viable game in town

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for quite some time going forward, regardless of what we think about the rationale and
sustainability of those policies.

The discussion on the US economy once again proved to be quite interesting. On the economic
front, the views of pundits naturally focused on the outlook for growth and inflation. The ideas
expressed by our panelists and clients proved to be mostly consistent with the consensus view
that the US economy is in a process of mending itself, implying that the risk of recession in 2017
remained relatively subdued and that gradual reflation would likely remain the base case
scenario going forward. We found the views of the different panelists to be materially more
positive compared to our in-house view, especially on the inflation front. One former FOMC
member actually mentioned to our audience that it would prove to be good “social policy” to
overshoot the inflation target because in that manner the risk of making a policy mistake would
be reduced. Still, this same pundit agreed with the view that the Fed was going to hike this
December. We continue to forecast that the Fed will NOT be able to hike rates in December,
because the incoming data will undershoot expectations. That said, as we argued in our latest
Weekly Strategy Report, the latest non-manufacturing ISM reading proved stellar, increasing the
risk of the Fed, in fact, being able to move in December.

The discussion on the continued poor growth of total factor productivity in the developed world
remained a key one during our fall meeting, just as it had been during our spring meeting, with
the question of the “how permanent” such “lull in productivity growth” would prove to be,
remaining the most uncertain one –see graph in the next page. From our side, as we have
argued in prior research pieces, we continue to think that the Fed “dots” remain too bullish --
hence our continued view that it makes a lot of sense Latam sovereign debt.

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It is important to mention that our panel on US politics occurred before the airing of the very
politically damaging tape on Donald Trump. Still, our pundit mentioned that the election was still
Clinton’s to lose because the Electoral College math will most likely continue to work against
candidate Trump. According to our political panelist, the election, if in the end turns out to be
close, will be decided in Pennsylvania. We do think that the release of the lewd language tape
during the weekend will prove an insurmountable obstacle for Trump. The different betting sites
are pricing-in a very large lead of Clinton versus Trump at this time, and we think that such
difference will prove insurmountable, because, in our view, Trump has now most likely lost the
female vote and the support of the Republican party establishment. Our political pundit
mentioned that if Trump wins it will most likely happen because key members of the Democratic
Party base, such as minorities, stayed home on election-day. Also of relevance, our US political
pundit argued that the republican majority in the Senate was now looking vulnerable, but that
the house would most likely remain in the hands of the Republicans. In other words, going
forward a divided government seems to be the base case scenario.

As expected, the Argentina story continued to be one of the key topics of conversation among
Latam leaders and investors. Of high relevance, a senior IFI member commended the fact that
Minister Prat-Gay had decided in favor of participating in the WB’s Pacific Alliance panel that
was held in DC during the weekend. Argentina entering the Pacific Alliance group would
naturally prove to be a very positive market development (because the participation of
Argentina in this group would necessarily force the country to meaningfully change regulations).
The views of two major rating agencies on the credit were constructive, but clearly not as
positive as the view held by senior IIF members. One senior member of a rating agency argued
that the agency would “take its time” in the process of upgrading Argentina, because the fiscal
remained difficult and good growth would likely prove difficult to achieve. In terms of the risks

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attached to the credit, the pundits mentioned (1) an incapacity of the authorities to tackle the
fiscal in an aggressive-enough fashion, (2) the possibility of high inflation failing to subside in the
short-term, (3) growth not coming back fast enough, and (4) all of the above conspiring to force
a loss of Macri’s coalition in the 2017 mid-term elections. As one of our panelists mentioned, “if
we could just cross-over 2017 faster, things would look so much easier!” From our side, we
continue to think that Argentina’s story will continue to prove a very profitable one. Our view
remains predicated on our conviction that the FX rate will continue to trade strong going
forward, in that manner allowing for disinflation to occur faster than market expectations.

On Brazil, the mood continues to be supportive with investors remaining interested in the
potential “new story” that the impeachment may have brought upon the markets. After the
notable relief rally that has taken place, all interest is naturally starting to move away from
politics, and instead turning to monetary and fiscal policy. We think this is a clear sign that after a
long an tumultuous period, the country is (finally) getting back to normal.

On the monetary front, our sense from listening to public officials and investor’s feedback and
questions, is that the markets are now mostly focused on the “how fast” the BCB will cut rates,
now that it seems probable that headline inflation has started to mean-revert, and that it is
doing so at an apparently decent rate. The authorities repeated many times that the BCB
stance would be one of maintaining a “conditional reaction function” when asked about the
velocity and path of the forthcoming adjustment process. The consensus seems to expect a
25bps cut in the next COPOM meeting and most agree that the markets may be surprised by
the size of the adjustment. The BCB seems to believe that risk factors are improving and seems
more constructive on the political outlook and, hence, the fate of fiscal reforms. Authorities are
aware that there is a long way ahead on the fiscal side. Nevertheless, officials are becoming
more confident that there is an understanding amongst politicians that if Brazil wants to recover

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growth, confidence has to return. Lastly, the authorities emphasized that the relevant horizon is
not fixed –it moves over the time– and that the BCB is NOT planning to undershoot the inflation
target.
Moving to the fiscal side, having better policy makers and a solid economic team has been
priced-in. Looking forward, it’s all about speed, delivery and execution. The investors that
attended our meetings seemed to be more hopeful on the outlook of reforms, and a senior
member of one of the leading rating agencies mentioned that he would be “very surprised” if at
least some of the key reforms are not approved (keep in mind that the lower house approved
the spending cap bill in recent hours by a very comfortable margin). Virtually all pundits that
participated in our conference reiterated to our audience that regardless of what happens in
the reform process, the Debt/GDP ratio of the sovereign would continue to increase, an issue
that would most likely delay, by many years, the eventual return of Brazil to investment grade
status. A senior member of a rating agency reminded the audience that prior experiences of
countries being able to move back from junk status to investment-grade status had taken an
average of 10 years.
When asked about what could force additional reductions in the rating of Brazil, a senior
member of one of the three leading rating agencies mentioned that the current rating already
included enough cushion of additional bad news, and reiterated that Brazil was most likely NOT
a lower rating credit because the banking sector was well-capitalized, and because the
situation in Petrobras was looking more hopeful. On the political front, the view of the pundits was
one of cautious optimism. The Social Security reform is an aggressive reform that may be
approved in the third quarter of 2017. In terms of what may happen in 2018, the view of XP’s
political expert, Richard Back, is that the outcome of the election will remain heavily dependent
on the pace of growth of the country at that time, but that the recent regional elections had
delivered clear evidence that the country is shifting towards more liberal economics. The
chances of the PT being able to win the election in 2018 seem very low, according to Richard.
To recap, the political environment will face some bumps down the road, but there is a sense of
an underlying improvement in the social-political scene that will play a major role in putting the
country back on track (please refer to the recent comments by my colleagues Zeina Latif,
Daniel Cunha, and Richard Back for further color on Brazil).

Despite the loss of the Santos administration in the national plebiscite on the FARC peace
agreement, the authorities of Colombia delivered a relatively upbeat outlook on the current
account adjustment (occurring faster than initially expected), the fiscal story (the Finance
Ministry remains hopeful on the possibility of tax reform being approved before the year-end),

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inflation, and the future performance of growth. On the growth front, the authorities at the
Finance Ministry reminded the audience that the 4G project would help to make up for some
portion of the foregone growth dynamics that the hydrocarbon industry had delivered for so
many years. The Central Bank seems comfortable with lower growth taking place, however, as
such lower growth is bringing the current account imbalance and the new reality of national
income (ex-post the commodities bust) closer.
On the fiscal front, the authorities reiterated that there was no option different to the one of
introducing a material tax reform legislation (in terms of size) to Congress. The simple reality is
that Colombia needs to recover the 3% of GDP in fiscal revenues that the country lost on the
back of the collapse in oil prices. According to the authorities, the reform will be introduced this
week, and it will prove to be an unpopular one, as it will include material increases in the VAT
(from 16 to 19%). When asked why the government was confident of the approval of the reform,
despite the unexpected loss in the plebiscite, senior members of the Santos administration
mentioned that the if the reform is not approved, the members of Congress would see a
reduction of more than 50% in the allocation of new investment in their respective regions, and
with congressional elections taking place in March of 2018, their power to deliver to their
respective constituents would be materially affected.
We agree with such view. As we argued in our latest Colombia Strategy, “Unlike what we
perceive is the consensus view of the market, we do not think so. Here is our reasoning. Vice
President Vargas Lleras remains the most probable winner of the 2018 election, and he DOES
NOT want to see an erosion of Colombia's credit rating because the financing equation under
his presidency would become increasingly complicated. We also think that the "uribismo" will do
its part to ensure that tax reform makes it through Congress, because, again, the “uribismo”
wants to regain power in 2018. Now, the Santos administration will most likely be forced to
negotiate with the different political forces of the country in order to be able to get enough
support in Congress to approve the reform. The quid-pro-quo of this negotiation will be granting
increased political power to VP Vargas Lleras (and reducing the participation of the liberal and
the conservative party in the executive), and the re-writing of some key parts of the Habana
agreement (former President Uribe’s condition to participate in a national unity government).”
Regarding the view of the rating agencies on Colombia, they remain concerned about three
specific topics: (1) the future prospects of oil production, (2) the implementation of a good-
enough tax reform in conjunction with additional fiscal consolidation, and (3) the future pace of
potential growth. A good-enough delivery of 4G projects could boost economic growth, and a
failure of the tax reform project would most likely generate a need to revisit Colombia’s rating. In
other words, there is no room for error here. Tax reform needs to be approved if Colombia is to
maintain its current rating.
The discussions on Mexico focused on the future monetary policy actions, and the expected
fiscal path of the country. On the monetary front, the authorities delivered an unequivocal
message of the board doing what it has to do to maintain its credibility unaffected. There were
many questions from the audience regarding the reasoning of Banxico behind the decision to
hike rates in order to try to contain FX weakness. Some investors believe that hiking rates
increases the cost of hedging, and hence the strategy risks forcing foreigners to sell their M-Bono
exposure. The answer from the authorities was one of the necessity to maintain credibility levels
unchanged, even if the cost of the decision was less growth in an already slowing economy,
and despite headline inflation remaining low.
The CB board believes that it is a mistake to assume that the fact that the markets have so far
not seen meaningful pass-through inflation, the performance can just be simply projected into
the future; “maybe yes, maybe no”. The view of Banxico is that it will continue to do what it has
to do to keep inflation expectations anchored, even if the cost of the moves is high (because

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clearly growth is slowing and hiking rates will only force growth even lower). The CB authorities
also seem relatively concerned with the current size of the current account deficit. The
authorities reminded investors that they had discontinued the FX intervention options scheme,
because it had become too predictable.

The authorities once again told investors that they “do not target the USDMXN” but that they will
maintain the discretion to intervene when and if circumstances so warrant. One member of the
audience asked if Banxico would cut rates under a Clinton victory, a question that was obviously
not answered, but one that goes directly to the main structural issue supporting the USDMXN
trade going into the year-end. The view of the rating agencies and the IFIs on Mexico was
relatively constructive, but questions remain on the possible contingent liabilities of Pemex. That
said, as one pundit argued, “things are looking better now compared to some months ago”. The
agencies and the World Bank once again mentioned that achieving the approval of structural
reforms was a clear welfare-enhancing event and one that would eventually serve to push
growth higher. The rating agencies do feel that the 2017 budget is an austere one, but they
once again stressed that the key word in this discussion remains: “implementation”.
Key Market Convictions
World Equity Markets: We maintain our longer-term fundamental view on world equity markets.
From the standpoint of the US Central Bank, as we argued last week, we think that IF the data
collaborates, interest rate hikes will come, yet IF the data fails to support convictions, the Fed will
keep rates on hold for longer. As we have argued repeatedly in prior publications, we expect
the forthcoming data to disappoint market expectations. Hence, we continue to forecast that
market and official expectations on the velocity and size of upcoming monetary tightening will
prove erroneous. We continue to think that SPX earnings will fall on a y/y basis this year and that
such fact remains a material headwind for the markets, as it is difficult to square negative growth
in corporate net income with increased private sector CAPEX. We continue to think that very
high levels of liquidity and ridiculously low bond yields will continue to force accounts to hold
high dividend stocks, in that manner keeping the markets from correcting meaningfully. We
continue to think that EM equity markets will materially outperform DM equity markets going into
the year-end and most likely during 2017. We are revising upwards our YE targets on the
Bovespa and the Mexican Bolsa (see the last page of this document).

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Fixed Income: Despite the latest rhetoric coming out of the Fed, and despite the recent
increases seen in developed world bond yields, we maintain our forecast that the US 10-year will
be trading at 1% by early 2017. We maintain our long-standing lukewarm view on the
fundamentals of the US economy. We believe that low productivity growth remains a major
hurdle for the ongoing US economic recovery, and we see no reason to forecast that we are
close to a point in which productivity growth will accelerate materially. Our view remains that
the US Central Bank will NOT increase rates further this year or next because of the simple fact
that future data will make it impossible to do so. In fact, as we have argued at length in the past,
we consider that the largest risk is one of the Fed being forced to ease policy in 2017. We
continue to think that unless the developed world is able to move forward with additional
infrastructure-led stimulus policies and additional structural reforms (comprehensive tax reform,
especially in the US, and pension reform in most of the developed world), activity will remain
depressed and potential growth estimations will continue to adjust downwards.

We continue to think that the US’s Terminal Rate is not 3% as the Fed currently says, but rather
somewhere around 2%, as the USD swap curve is currently projecting. We see the 10-year
German Bund ending the year at or very close to 0%. We maintain that it is entirely possible that
the Japanese authorities will decide in favor (at some point in the near future) of following
through with a “helicopter money” type of policy in order to continue its campaign to beat
deflation. Despite all the lingering uncertainties, we think that hard currency higher-yielding
Latam bonds will continue to deliver very good returns to investors this year (see back of this
document for more).

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FX Markets: We continue to argue that the US economy CANNOT grow well in a strong USD
environment. A strong USD is clearly a large risk for SPX earnings, and for US manufacturing in
general. Unless US salaries accelerate fast starting now, and unless job security feelings change
dramatically in the short-term, we think that US consumption, especially on durables, will slow
going into 2017. As we have argued in the past, we have a problem squaring the fact that US
consumption has continued to grow well, while the rest of the economy has been in a technical
recession for quite some time already. Hence, we continue to expect the DXY to mean-revert
further, as markets incrementally price-in future Fed inaction. We believe that high-carry
currencies will perform better versus the USD compared to G7 currencies.

We remain steadfast in our call on oil prices heading higher as the year evolves. At current
prices, a very large portion of the world’s oil production is simply uneconomical. Hence, we
project that CAPEX will continue to fall going forward. We expect WTI to end 2016 trading at $55
(was $50) and we see oil prices reaching $70 at some point in 2017. We expect the € to end the
year at 1.10, the ¥ at 105, the USDCOP at $2,850, the USDCLP at $650, and the USDMXN at $17.
We continue to think that Clinton will win the US election (because the Electoral College math
remains very complicated for the Trump camp), and such fact should prove positive news for
the USDMXN. We see the USDBRL ending the year at $3.15. We also believe that the USDARS will
perform much better than most investors expect, at least judging from where the 12-month NDF
is currently pricing the currency. We see the USDARS trading at $14.5 by year-end 2016, even
after accounting for the high likelihood of the Argentine Central Bank deciding in favor of
accelerating the pace of USD purchases.

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XP Securities Investment Monitor (2016)

Numbers In Red, New Target
Expected Possible Additional
YTD Return Return (Full-Year) Return From Now
Equities Current Beginning 2016 (In USD's) YE (2016) Target (In USD's) To YE 2016

Mexican Bolsa 48,270 42,977 2.69% 49,500 16.94% 14.25%

Brazilian Bov espa 61,426 43,349 74.54% 63,000 82.70% 8.16%
Colombia COLCAP Index 1,348 1,153 26.81% 1,400 35.23% 8.42%
S&P 500 2,165 2,050 5.60% 2,125 3.66% -1.94%
MSCI Emerging Markets 915 794 15.20% 925 16.48% 1.28%
Japan Topix 1,351 1,547 1.50% 1,500 11.30% 9.80%
Shanghai Composite 3,048 3,539 -16.62% 3,250 -10.32% 6.29%
German DAX 10,624 10,743 1.57% 10,700 0.92% -0.65%
Spain IBEX 8,702 9,544 -6.36% 9,000 -4.45% 1.91%
Borsa Italiana (FTSE MIB) 16,632 21,418 -20.24% 18,000 -14.84% 5.40%
EuroStoxx 3,036 3,267 -4.56% 3,100 -3.85% 0.71%

Fixed Income

US 10-Year 1.72% 2.27% 6.65% 1.25% 11.29% 4.64%

US 30-Year 2.45% 3.01% 14.43% 2.00% 26.12% 11.69%
Embi-Global Index 769 670 14.81% 800 19.40% 4.59%
High-Yield Index 168 150 12.05% 172 14.79% 2.74%
Bloomberg G. Dev eloped Bond Index 117.25 106.59 10.00% 124.0 16.33% 6.33%
Colombia USD 2026, 3.875% 2.43% 3.83% 14.45% 1.97% 19.38% 4.93%
Brazil USD 2025, 4.25% 4.37% 7.14% 26.17% 3.80% 32.10% 5.93%
Mexico USD 2026, 4.125% 3.12% 4.14% 11.17% 2.56% 16.88% 5.71%
Peru USD 2027, 4.125% 2.67% 4.29% 14.23% 2.02% 20.57% 6.34%
Argentina Bonar 2024 6.07% 7.79% 16.16% 5.50% 21.18% 5.02%
Venezuela USD 2027, 9.25% 19.34% 26.12% 59.11% 18.77% 68.60% 9.49%
Prov ince of BA 2021, 11.75% 6.51% 9.47% 17.97% 6.00% 21.56% 3.59%

Bloomberg EM Local Sov ereign Index 130.58 121.84 7.17% 135.0 10.80% 3.63%
2024 M-Bono, Mexico (MXN) 5.95% 6.12% -3.63% 5.25% 11.70% 15.33%
2042 M-Bono, Mexico (MXN) 6.55% 6.93% 0.57% 6.00% 20.46% 19.88%
2024 TES, Colombia (COP) 6.98% 8.27% 23.04% 6.75% 29.41% 6.37%
2028 TES, Colombia (COP) 7.26% 8.97% 31.75% 7.00% 38.47% 6.72%
Peru 2020 Soberanos (PEN) 4.72% 6.48% 11.19% 4.60% 21.49% 10.30%
Brazil NTNF Current 10-Year 11.39% 16.44% 64.90% 11.00% 72.84% 7.94%
Brazil 8.5%, January 2024 (BRL) 9.87% 11.13% 42.33% 9.50% 48.42% 6.10%

Italy 2024 1.28% 1.59% 6.50% 0.88% 8.94% 2.44%

Spain 2024 1.02% 1.71% 9.87% 0.62% 12.07% 2.20%
Portugal 2024 3.16% 2.34% -0.85% 2.96% 0.20% 1.05%
Germany 2026 -0.02% 0.50% -117.38% 0.01% 6.90%

Pemex USD 2023, 4.25% 4.83% 5.94% 11.23% 4.08% 16.56% 5.33%
Petrobras 2023, 4.375% 6.05% 11.28% 42.36% 4.80% 53.44% 11.07%

Currencies

USDMXN 18.88 17.26 -8.57% 17.00 1.53% 10.10%

USDCOP 2,927.14 3,174.00 8.43% 2,850.00 11.37% 2.93%
USDARS 15.19 12.93 -14.90% 14.50 -10.83% 4.07%
USDCLP 669.73 708.00 5.71% 650.00 8.92% 3.21%
USDBRL 3.22 3.96 23.17% 3.15 25.71% 2.54%
USDPEN 3.39 3.41 0.62% 3.15 8.25% 7.63%
EURUSD 1.12 1.09 2.64% 1.10 1.33% -1.31%
USDYEN 103.67 120.55 16.28% 105.00 14.81% -1.47%
USDCNY 6.71 6.49 -3.19% 6.65 -2.35% 0.84%

Commodities

Crude Oil (WTI) 51.17 39.98 27.99% 55.00 37.57% 9.58%

Gold 1,257.00 1,061.00 18.47% 1,400.00 31.95% 13.48%
Copper 219.75 213.00 3.17% 230.00 7.98% 4.81%
CRB-Index 190.04 176.14 7.89% 200.00 13.55% 5.66%

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Disclaimer

This communication is from XP Securities LLC’s (“XP Securities”) Sales and/or Trading Desk, or broker
dealer representatives and is not a product of XP Securities’ Research Department. Any views expressed
in this commentary are short-term and are not objective or independent of the interests of the authors or
other XP Securities’ Sales and/or Trading desks, who are active participants in the markets, investments
or strategies referred to in this communication. The material is provided for informational purposes only
and is not an offer, recommendation or solicitation to buy or sell any of the securities mentioned above.
The material does not constitute, nor should it be regarded as, investment research or a research report
or securities recommendation, and does not take into account whether any product or transaction is
suitable for any particular investor. The views expressed in this material do not constitute a complete and
substantive analysis of all material facts regarding any issuer, industry or security, and therefore are not a
sufficient basis alone upon which to base an investment decision. This material is not a recommendation
to buy or sell any securities. Investors should independently evaluate particular investments and
strategies. The material is merely intended to provide the personal observations or views of individual
traders, sales personnel, or desk analysts, and may be different from or inconsistent with the
observations and views of XP Securities’ research analysts, other XP Securities institutional traders, sales
personnel or desk analysts or the proprietary positions held by XP Securities. The accuracy of the
corresponding information has not been verified or confirmed; accordingly, no representation or warranty,
expressed or otherwise, is made as to, and no reliance should be placed on, the fairness, accuracy,
completeness or timeliness of the information. The observations or views expressed in the material may
be changed by the trader, sales person or desk analyst at any time without notice.

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