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Brazilian breakevens tighten on higher market expectations of an inflation target reduction

February 13, 2017

Long NTN-Bs widened substantially , as market debates the odds of a reduction of the CPI target for 2019 as early as June

With information available until 6:30pm Brasilia time

Highlights

  • Brazilian long real rates increased, as the back end of the NTN-B curve widened substantially (Aug-50: +9bps to 5.30%), amid recent market debates on the likelihood of a reduction of the inflation target for 2019 as early as June. Accordingly, long breakevens tightened (5y5y: 4.98%, -20bps).
  • In Colombia, the front end of the IBR swaps curve traded higher, still reacting to Banrep’s minutes (see Macro Backdrop). The 6-month widened to 6.93% (+5bps). The cuts implied in the curve for this year are between 98bps and 124bps, pending of the term premium assumption.

Macro Backdrop

BRAZIL
  • 2017 inflation expectations dip below BCB’s target. According to BCB’s Focus survey, inflation expectations for 2017 slid to 4.47% (-17bps) and remained anchored at 4.5% for 2018 onwards. The median of professional forecasters’ expectations for the Selic policy rate stood flat at 9.50% for YE17 and at 9.00% for YE18. The market sees a slightly stronger BRL ahead: 3.36/USD (from: 3.40) in YE17, 3.49/USD (from: 3.50) in YE18 and 3.55/USD (from: 3.57) in YE19. The median of GDP growth expectations for 2017 was downwardly revised to 0.48% growth (from: 0.49%). Forecasts for 2018 improved to 2.30% (from: 2.25%), and those for 2019 remained unchanged at 2.50%. See BCB Report
  • BCB called a roll over auction of up to 6,000 FX swaps on February 14. If this pace is maintained the BCB will roll over 35% of the outstading FX swap contracts (total amount maturing March 1: USD 6.95 billion).
COLOMBIA
  • Banrep’s minutes suggest that in the short-term the majority of the board will commit to ensuring that inflation and inflation expectations record a robust reversion to the target. The minutes of the January monetary policy meeting reveal that within the majority of the board, future rate cuts should be subject to the evolution of inflation expectations and the speed of inflation’s convergence to the target. In contrast, the minority emphasized that the risk of an excessive deceleration of domestic demand growth had increased. Additionally, since the previous meeting, the board notes that global uncertainty has increased, while activity has been weaker than initially expected. Overall, there is broad acknowledgment of the need for an easing cycle amid a negative output gap and reverting inflation, but the rise of inflation expectations has likely delayed further rate cuts.
  • We also see the need for easing ahead, but the timing of the next rate hike will depend on inflation and inflation expectations. We expect the upcoming February inflation to reflect the one-off impact from the tax reform’s VAT hike. Taking this into consideration and the fact that 2017 inflation expectations remain beyond 4%, we expect the committee to remain cautious in the coming months. However, given the negative output gap and the historically high real interest, Banrep will be vigilant not to suffocate the economy. Hence, as inflation cools in the months ahead and the monetary policy horizon shifts to 2018, easing will likely unfold. We see the policy rate ending the year at 5.5%, with the majority of the rate cuts coming in 2H17. Full Report

Market Developments 

  • GLOBAL MARKETS: Risk aversion decreased, as with US Corporate Credit Spreads fell and equity markets on the green. DM rates widened, as both US Treasuries (10-year) and long EONIA rates (10-year) increased to 2.44% (+3bps) and 0.56% (+4bps), respectively. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities were mixed (CRB futures index: -1.02%). Iron Ore rallied (4.74%) and Soybean fell 0.45%. In LatAm currencies, the movements differ. The BRL slightly appreciated to 3.1103/USD (+0.15%), a level last seen on June 2015. The MXN strengthened 0.11% to 20.32/USD, whereas the CLP depreciated to 642.80/USD (-0.46%). The COP underperformed among the major currencies, depreciating to 2,874.05/USD (-0.70%) dragged by oil (WTI: -1.82% to USD 52.82/bbl). FX & Commodities Tracker 
  • CDS SPREADS & EXTERNAL BONDS: All over LatAm, the 5-year tenor credit spreads fell. In Chile, spreads decreased to 75bps (-2bps). Colombian risk premium narrowed to 139bps (-5bps). For Mexico, they traded at 144bps (-8bps). Brazilian CDS fell the most, reaching the 21-month low at 218bps (-10bps). External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: DI Futures rates traded range bound. The Jan-19 went up 1bp to 10.10% and the Jan-21 fell 1bp to 10.25%. The long end (past 2030s) of the NTN-B curve widened substantially, as the Aug-50 went up 9bps to 5.30%. Amid recent market debates on the likelihood of a reduction of the inflation target for 2019 as early as June, breakevens tightened (5y5y: 4.98%, -20bps). Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican rates traded higher. In TIIE swaps, the 1-year widened 2bps to 7.20% and the 10-year went up 1bp to 7.88%. The curve now implies 100bps in rate hikes for 2017. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia:  Camara rates traded range bound. The 1-year stood flat at 2.96% and the 10-year widened 2bps to 4.15%. Chile Rates Tracker  In Colombia, the front end of the IBR swaps curve traded higher, still reacting to Banrep’s minutes (see Macro Backdrop). The 6-month widened to 6.93% (+5bps) and the 10-year went up to 5.27% (+3bps). The cuts implied in the curve for this year are between 98bps and 124bps, pending of the term premium assumption. Colombia Rates Tracker

Upcoming Events

  • In Brazil, retail sales for December will be the highlight of economic activity releases (Tue.). We expect a contraction of 1.9% in the core segment, a payback from November’s increase. In the broad segment (which includes vehicles and construction material), we expect a setback of 0.4%. In addition, December’s real service sector revenues will be released (Wed.), for which we expect a decline of 4.4% y/y. Also, industrial business confidence (CNI) for February will be released (Thu.). Moreover, the Central Bank’s activity index (IBC-Br) may be disclosed. We expect the IBC-Br to drop 0.3% m/m in December. Still, January’s Current Account Balance will be released (Fri.). We expect the current account deficit to reach USD 5.6 billion. Finally, direct investment in the country (former FDI) in January will be released (Fri.), for which we expect to sum up to USD 10 billion.
  • In Chile, all eyes will be on February’s monetary policy meeting (Tue.). We believe BCCh will cut by 25bps, taking the policy rate to 3.25%.
  • In Colombia, the market will watch important activity data. Fedesarrollo will publish the consumer confidence index for January (Wed.). Also, the National Institute of Statistics (DANE) will publish the December trade balance (Fri.). We expect a trade deficit of USD 455 million, smaller than the USD 1.4 billion deficit recorded one year ago. Furthermore, the DANE will also release activity data for December (Fri.). We expect manufacturing to expand 0.5% y/y, while retail sales are likely to grow 2.5% y/y.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa



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