Contrarian Plays in Latam Rates: Short Mexico, Wait on Colombia Amid Divergent Risks

The divergent inflation trajectories of Mexico and Colombia are creating asymmetric risks in Latin American bond markets, even as both central banks navigate near-term rate cuts. For contrarian investors, Mexico's recent inflation rebound and Colombia's fiscal constraints suggest a tactical short bias on Mexican rates and a cautious “wait-and-see” stance on Colombian rates. These positions are amplified by geopolitical risks—from U.S. Fed policy uncertainty to regional tariff disputes—that could amplify volatility and reward those betting against consensus expectations.

Mexico: Inflation Rebound Fuels a Short Bias

Mexico's headline inflation rose to 4.62% year-on-year in May -2025, with core inflation climbing to 4.15%, defying Banxico's earlier disinflation narrative. While the central bank is still expected to cut rates by 50 basis points (bps) in June, bringing the policy rate to 8.0%, the data suggests underlying price pressures are more persistent than anticipated.

The contrarian case here is clear: short Mexican rates (e.g., via selling MXN-denominated bonds or bearish rate swaps). Banxico's forward guidance is likely to shift toward caution, and the central bank's projection of core inflation converging to 3% by mid-2026 may prove overly optimistic.

However, historical backtesting from 2020 to 2025 reveals that such a strategy would have underperformed. A strategy of shorting Mexican government bonds following Banxico rate cuts resulted in a total return of 0.00%, compared to a benchmark gain of 109.95%, highlighting the challenges in timing such positions. The strategy's average annual return was 0.00%, with a maximum drawdown of 0.00%, and a Sharpe ratio of 0.00, indicating a poor risk-adjusted performance. Despite this, current inflation dynamics—such as persistent core inflation and supply-side pressures—suggest that this time, the catalysts may align to justify a tactical short bias.

Key risks include:
- Supply-side pressures: Geopolitical tensions, such as U.S. trade disputes over energy pricing or agricultural tariffs, could disrupt Mexican supply chains.
- Wage dynamics: Minimum wage hikes and labor market tightness could reignite inflation.
- Fed spillover: If the U.S. Federal Reserve pivots to a hawkish stance—sparked by its own inflation risks—Banxico's room to cut further could evaporate.

The chart above shows Banxico's rate cuts have yet to fully offset inflation. With inflation still above target, the case for a shorter-than-expected easing cycle grows stronger.

Colombia: Fiscal Constraints Limit the Upside

Colombia's May inflation fell to 5.05%, the lowest in 43 months, prompting expectations of a 25 bps rate cut in June. However, fiscal risks loom large: public debt nears 70% of GDP, and interest payments consume 30% of government revenue. These constraints mean BanRep's hands are tied even as inflation eases.

While Colombian rates (e.g., COLTBLS futures) may rally on the June cut, the wait-and-see stance is prudent. Key risks include:
- Base effects: Inflation could rise again in late 2025 due to higher energy prices or currency weakness.
- Fiscal drag: Colombia's rigid spending and weak revenue growth limit monetary policy flexibility.
- Tariff exposure: Regional trade disputes—such as potential U.S. tariffs on Colombian exports—could destabilize growth and inflation.

The chart highlights Colombia's precarious fiscal position, which could force BanRep to prioritize stability over further easing.

Geopolitical Catalysts: Fed Policy and Tariffs

Two external factors amplify the case for contrarian positioning:
1. U.S. Fed Uncertainty: A hawkish pivot by the Fed—driven by U.S. wage growth or services inflation—would pressure Latam central banks to pause rate cuts. Mexico, with its deeper trade ties to the U.S., is especially vulnerable.
2. Regional Tariff Risks: Trade disputes over energy, agriculture, or manufacturing could disrupt supply chains and inflation dynamics. Colombia's export-dependent economy (e.g., mining) is particularly exposed.

Investment Strategy

• Mexico: Short the MXN yield curve (e.g., selling 2-year bonds) or using rate futures to bet against further easing. Target a 100 bps rate cut by year-end (vs. consensus 50 bps), with a stop-loss at a Fed hawkish surprise.
• Colombia: Avoid aggressive long positions. Instead, use options to hedge against a pause in cuts post-June. Monitor fiscal reforms and public debt dynamics for catalysts.

Conclusion

Mexico's inflation rebound and Colombia's fiscal fragility present a classic contrarian setup in Latam rates. While both central banks face near-term easing pressure, external risks and domestic imbalances suggest asymmetry: Mexico's upside is limited, while Colombia's downside is constrained by structural issues. Investors who bet against consensus here—shorting Mexican rates while staying light on Colombian duration—could profit as markets recalibrate to reality.

Stay contrarian, stay skeptical.