Itaú BBA - After the Copom minutes, a 75-bp cut becomes the market’s baseline

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After the Copom minutes, a 75-bp cut becomes the market’s baseline

June 6, 2017

The board seems to reaffirm that the next move, in late July, is more likely a 75-bp cut.

With information available until 6:30pm Brasilia time

Highlights

  • The Brazilian curve bull-steepened after the release of the Copom minutes (see Macro Backdrop). The board seems to reaffirm that the next move, in late July, is more likely a 75-bp cut. For the next Copom meeting, the curve now implies roughly 71bps in rate cuts from 61bps as of Monday (June 5). Also, the BRL appreciation could have pressured rates during the session. In DI futures, the Jan-18 narrowed 10bps to 9.32% and the Jan-21 went down 15bps to 10.46%. 
  • In FX, commodity-linked currencies posted gains. Andeans appreciated at the margin (COP: +0.15% to 2,893.69/USD; CLP: +0.01% to 668.55/USD). The MXN is trading at 18.24/USD (+0.56%) to its strongest level since August 2016. The BRL appreciated 0.56% to 3.2782/USD.

Macro Backdrop

BRAZIL
  • The minutes from the Copom May meeting managed to be quite informative despite the heightened uncertainty in which the authorities are operating. The key points of the minutes, in our view, lie in paragraphs 17-22, in which the authorities indicate that the uncertainty shock may have disinflationary as well as inflationary implications, but that, given the stage of the cycle, policy anticipation is no longer on the table. It seems to reaffirm that the next move, in late July, is more likely a 75bps rate cut, and that the following one could well be of a moderately slower cut. We retain the view that after July the Copom will slow to a 50bps pace, and that the Selic will end the year at 8%. Details of the authorities’ thinking are likely to emerge with the publication of the Quarterly Inflation Report at the end of the month. Also by end-June the National Monetary Council (CMN) will announce the inflation target for 2019. Given that market expectations for 2019 and beyond are at 4.25%, we expect the government to set the target at this level. Full Report
  • The Senate’s Economic Affairs Committee (CAE) has approved the core text of the labor reform proposal with 14 votes in favor and 11 against. The bill must also be approved at the Upper House’s Social Affairs (CAS) and Constitution & Justice (CCJ) committees.
  • According to Anfavea, auto production reached 237k in May, in line with our forecasts (236k). We estimate that production rose 10.8% mom/sa, maintaining a volatile pattern since a rebound in November 2016. The breakdown shows improvement in both trucks and buses (10.3% mom/sa) and light vehicles (11.7% mom/sa). Employment in the auto sector rose 7k to 128k jobs, a strong growth that should affect positively forecasts of formal jobs (Caged) for the same month. Also, exports rose 1.0% mom/sa and 51.1% yoy, while domestic sales grew 1.0% mom/sa and 16.8% yoy over the same period. The strong year-over-year figures highlight the improvement from 1H16, yet the sector activity level remains well below 2011-2013. Inventories remain at low levels, not only in absolute terms but also relative to sales. Along with other economic activity indicators (such as energy consumption, imports and capacity utilization) our preliminary forecast for industrial production in May is at -1.0% mom/sa. 
  • The BCB placed the full offering of 8,200 FX swaps. After closing, the central bank called for a roll over auction of up to 8,200 contracts on June 7.
MEXICO
  • The monthly proxy for private consumption is weakening at the margin, as real wages fall (due to higher inflation) and other fundamental variables - with the exception of employment - turn less supportive. According to calendar-adjusted data reported by the statistics institute (INEGI), private consumption in the domestic market expanded 3% year-over-year in 1Q17, after expanding 3.4% in 4Q16, showing resilience to the macroeconomic headwinds (i.e.: increase of inflation given the spike of gasoline prices and MXN depreciation, lower confidence from deteriorated relations with the U.S., and tighter macroeconomic policies in the form of rising domestic interest rates and fiscal cuts). At the margin, however, we see deterioration, considering that seasonally-adjusted private consumption fell 0.4% month-over-month in March, and quarter-over-quarter annualized growth slowed down significantly (to 2.3%, from 3.9% qoq/saar in 4Q16). 
  • We believe that private consumption will slow down more visibly in coming quarters because of weaker labor market conditions. The real wage bill has only slowed down moderately because robust formal employment (growing at an average pace of 4.3% year-over-year in the first four months of 2017) has prevented this from happening. However, in our view, formal employment creation will eventually deteriorate as investment slows down, which together with rising inflation, will reduce consumption growth. Moreover, other fundamentals of private consumption (credit, remittances expressed in pesos and consumer confidence) have turned less supportive since last year. Full Report

COLOMBIA

  • In May, the disinflationary process progressed as shocks (El Niño and COP depreciation) dissipate, but non-tradable inflation remains sticky. Consumer prices increased 0.23% (0.51% one year prior), broadly in line with our 0.21% forecast, but below market consensus (0.32%). As a result, annual inflation moved closer to the central bank’s 2%-4% tolerance range, by reaching 4.37% (4.66% previously), lowest since February 2015. Core inflation also moderated but remains high, while non-tradable inflation, excluding food and regulated goods, is sticky. The monthly inflation gain was led by housing service inflation (0.49%), while health inflation (0.43%) was the only other division to pull prices up in the month of May. 
  • With a widening output gap, loosening labor market and stable COP, we expect inflation to continue to moderate ahead. We see inflation reaching 4.1% by yearend (5.8% for 2016), before settling comfortably within the target range next year. While falling inflation will likely be reflected in the continued decline in inflation expectations, the composition of inflation (a food inflation-led slowdown, while core measures remain sticky) would prevent the board from cutting rates much further this year. Our baseline scenario has the policy rate ending 2017 at 5.5% (75bps below the current level), with activity data also playing an important role in the upcoming rate decisions. Full Report
Market Developments 
  • GLOBAL MARKETS: Risk-off day, with the dollar (-0.25%) breaking another low since the US elections. Conversely, haven assets outperformed in the session: gold (+1.10%), JPY (+0.94%) and US Treasuries (10-year: -4bps to 1.71% - lowest since November 2016). Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities posted gains (CRB futures: +0.44%). Oil prices (WTI: +1.24% to USD 47.99/bbl) recovered some losses from previous sessions. Also, iron ore increased 1.78% and soybean went up 0.16%. In FX, commodity-linked currencies posted gains. Andeans appreciated at the margin (COP: +0.15% to 2,893.69/USD; CLP: +0.01% to 668.55/USD). The MXN is trading at 18.24/USD (+0.56%) to its strongest level since August 2016. The BRL appreciated 0.56% to 3.2782/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm Credit spreads for the 5-year tenor fell at the margin. Colombian spreads stood flat at 125bps. In Mexico, country risk fell 3bps to 11bps, its lowest levels since March 2015. Country risk in Brazil and Chile both fell 1bp to 237bps and 68bps, respectively. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bull steepened after the release of the Copom minutes (see Macro Backdrop). The board seems to reaffirm that the next move, in late July, is more likely a 75-bp cut. Also, the BRL appreciation could have pressured rates during the session. In DI futures, the Jan-18 narrowed 10bps to 9.32% and the Jan-21 went down 15bps to 10.46%. For the next Copom meeting, the curve now implies roughly 71bps in rate cuts from 61bps as of Monday (June 5). Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve bull flattened in the session, tracking US treasuries and a stronger MXN. In TIEE swaps, the 1-year fell 1bp to 7.44% and the 10-year narrowed 8bps to 7.30%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, long rates narrowed. In Camara swaps, while short rates edged up (1-year: +2bps to 2.48%), long narrowed (5-year: -4bps to 3.35%). Chile Rates Tracker In Colombia, yields also narrowed. In IBR swaps, the 1-year fell 6bps to 5.10% and the 10-year went down 3bps to 5.80%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, May’s IPCA consumer inflation will be released (Fri.). We forecast a 0.48% monthly rise, with year-over-year inflation slowing to 3.8% from 4.1%. Moreover, economic activity indicators will see a less busy week following the 1Q17 GDP release. Serasa may release its May retail activity index (Wed.), an important coincident indicator for IBGE’s retail sales. Finally, IBGE will release the monthly update of its Systematic Survey of Agricultural Production (Thu.).
  • In Mexico, INEGI will announce May’s CPI (Thu.). We expect a 0.13% month-over-month decline in the CPI, driven by the 23.3% reduction of regulated electricity tariffs by the Federal Electricity Commission (CFE) and the decrease of gasoline prices. Assuming our forecast is correct, annual inflation would increase to 6.15% year-over-year (from 5.82% in April). Finally, INEGI will publish April’s industrial production (Fri.). We expect a 2.8% year-over-year contraction (down from a 3.4% expansion in March), based on a deterioration of coincident indicators and a negative calendar effect. 
  • In Chile, the central bank will release the trade balance figures for May (Wed.). We forecast a USD 470 million surplus (USD 564 million surplus in May 2016), taking the rolling 12-month trade balance to USD 3.9 billion (USD 5.3 billion in 2016). Moreover, the National Institute of Statistics (INE) will publish nominal wage growth for April (Wed.). Wage inflation has gradually moderated as the labor market loosens, the economy cools and inertia stays low (as inflation is running below the target). Finally, inflation for the month of May will be published by the National Institute of Statistics (Thu.). We expect prices to be flat from April (+0.2% in April). As a result, annual inflation would dip to 2.4%, from 2.7% previously, closer to lower bound of the 2%-4% tolerance range.
  • In Colombia, Banrep will release the minutes of the monetary policy meeting held in May (Fri.). At the meeting, a split board decided to cut the policy rate by 25-bps to 6.25%, less aggressive than the 50-bp cut in the previous month. A tick-up in inflation expectations and sticky core consumer prices have created some unease in the board. Nevertheless all board members were in favor of further easing. The minutes will likely reflect heightened concern for inflation dynamics.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa




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