Itaú BBA - Brazilian markets sell off amid political uncertainties

Latam FI Strategy Daily

< Back

Brazilian markets sell off amid political uncertainties

May 18, 2017

Brazilian rates sold off with DI futures testing the circuit breaks upside limits.

With information available until 6:30pm Brasilia time

Highlights

  • Newspaper “O Globo” reported a plea bargain deal of Brazilian businessmen Joesley and Wesley Batista, approved today by Supreme Court Minister Luiz Edson Fachin, in which they cited the recording of a conversation in which President Michel Temer learns about the "purchase" of the silence of the former Speaker of the House of Representatives Eduardo Cunha. In a speech on Thursday, President Temer stated that he will not resign. Three scenarios may unfold: (1) the Supreme Electoral Court ousts Temer via annulment of the Dilma-Temer ticket; (2) an impeachment led by Congress; (3) resignation (see discussion below).
  • In LatAm FX, all currencies under our coverage depreciated. The MXN (-0.29% to 18.84/USD) was affected by the BRL’s volatility, but later in the session recovered after Banxico hiked, as we expected (see Macro Backdrop). The COP weakened 0.96% to 2,926.46/USD and the CLP posted losses of 0.89% to 675.16/USD. At last, the BRL sold off on political uncertainties, closing at 3.3758/USD (-7.01%).

Macro Backdrop

BRAZIL
  • By the Constitution, Congress has 30 days to elect a new president once the presidency becomes vacant (article 81, paragraph 1). Once elected, the new president will complete the mandate until the 2018 direct elections, held in October of next year. The specific rules over eligibility of Presidential candidates in this scenario are undefined, as there has never been an episode of indirect elections. However, there is nothing to prevent Congress from amending the Constitution and calling for direct elections to elect Temer's replacement, but this would take a few months and would most likely only be triggered by mass protests calling for direct elections. 
  • BCB released a note affirming it is monitoring the information recently disclosed by the press and acting to maintain normal market functioning. The authority concluded by stating that such monitoring bears “no direct and mechanical relation with monetary policy”. 
  • Still in the morning, the central bank called for an extraordinary auction of up to 40,000 FX swaps (USD 2 billion). At first, the BCB placed 24,675 contracts. For the August 2017 maturity, were placed 22,075 contracts (USD 1,103 million). For the October 2017, were placed 1,100 contracts (USD 55 million). For the January 2018, were sold 1,500 contracts (USD 75 million). A few moments later, the central bank placed the remaining 15,325 contracts out of the 40,000. For the August 2017, were sold 6,265 contracts (USD 313 million). For the October 2017, were placed 2,330 contracts (USD 117 million). At last, for the January 2018, were sold 6,730 contracts (USD 337 million).
  • In the afternoon, the central bank called for another extraordinary auction of up to 40,000 FX swaps. Initially, the BCB placed 26,675 contracts. For the August 2017 maturity, were placed 11,350 contracts (USD 567 million). For the October 2017, were placed 7,000 contracts (USD 350 million). For the January 2018, were sold 10,900 contracts (USD 545 million). A few moments later, the central bank placed the remaining 10,750 contracts out of the 40,000. For the August 2017, were sold 1,400 contracts (USD 70 million). For the October 2017, were placed 3,600 contracts (USD 180 million). At last, for the January 2018, were sold 5,750 contracts (USD 288 million).
  • In the usual roll over auction, the BCB placed the full offering of 8,000 FX swaps announced on Wednesday (May 17). After closing, the central bank called for a roll over auction of up to 8,000 contracts. In addition, the central bank announced daily auctions of up to 40,000 FX swaps from May 19 to 23. 
  • The National Treasury cancelled the weekly fixed rate auction, which usually takes place on Thursdays. In a note published in its website, the National Treasury announced extraordinary federal bond auctions, “due to the volatility observed in the market”. There will be three auctions of LTN (Apr-2018, Apr-2019 and Jul-2020), NTN-F (Jan-2023, Jan-2027) and NTN-B (Aug-2022, Aug-2026, May-2035 and May-2055). The respective administrative rules will be disclosed at the date of the auctions: May 19, 22 and 23. 
MEXICO
  • The Central Bank of Mexico hiked the reference by 25-bps (to 6.75%), in line with our call and surprising the market (only 13 out of 32 analysts, as per Bloomberg, expected the hike). In its last meeting, held in March, Banxico’s board decided to smooth the pace of monetary tightening by hiking 25bps, departing from the last six policy moves (50bps). Moreover, the Quarterly Inflation Report - published in the preceding week - signaled that policymakers were more mindful about the potential costs imposed on economic activity. Since then, however, inflation has accelerated and activity has surprised to the upside. Headline Inflation increased to 5.8% in April (from 5.4% in March), and the behavior of diffusion indexes (73% of items in the CPI basket showing inflation higher or equal than 4%) and service inflation provide evidence that second-round effects are materializing. This deterioration of inflation conditions, in our view, was the main reason that led Banxico to hike rates in May, considering that the board has pledged to prevent second-round effects. In the statement, the board mentioned that inflation will be “considerably” above the tolerance range around the Central Bank’s target in 2017 (rather than just above), and that the balance of risks for inflation has deteriorated. On the activity front, the statement mentions that the economy did not slowdown in 1Q17 (the GDP flash estimate came in at 2.7% year-over-year, above expectations), and that the probability for the materialization of downside risks has decreased.
  • We expect Banxico to deliver two more 25-bp hikes, in June and September, in lockstep with the Fed; and then stay put for the rest of year, as we believe that inflation will start trending down in September. Looking forward, according to May’s statement, Banxico remains focused on the same factors as before: second-round effects from the shocks affecting domestic prices (MXN depreciation and gasoline price spike), the relative monetary policy stance between Mexico and the U.S., and the output gap. In 2018, we expect the central bank to ease monetary policy a bit; bringing the reference rate to 6.75%, as the inflation shocks dissipate and the economy expands at a moderate pace. Full Report
CHILE
  • The central bank of Chile surprised most in the market by cutting the policy rate by 25bps for a second consecutive month to 2.5%. The cut came earlier than we were expecting – we believed the cut would only be implemented next month – and for nearly two-thirds of the market, according to Bloomberg as well as the majority in both central bank surveys prior to the meeting. Nevertheless, the lowering of the policy rate is in accordance with our call from late last year of a 100bp easing cycle from the 3.5% starting point. In line with the view that the current cycle has ended (at least in short-term) is the removal of the easing bias in the press release communicating the decision. Hence, it is unlikely that the upcoming Inflation Report forecast scenario includes guidance towards lower rates.
  • Our baseline scenario considers no further easing, while the start of a normalization process is likely by yearend 2018 as internal demand recuperates. However, activity is weak and the composition of the 1Q17 growth (0.1% year over year) hints that the risk of further weakening ahead is not negligible. If this scenario materializes, additional rate cuts later in the year are a possibility. Full Report Below
  • Growth in 1Q17 was the lowest since 3Q09 (-1.0%), as confirmed by the national accounts report. Activity expanded a mere 0.1% from one year ago, below the 0.2% growth estimated on the back of the monthly GDP proxy (IMACEC). After contracting 1.4% qoq/saar in 4Q16, the economy expanded 0.7% qoq/saar in the first quarter of the year. The improvement was driven by the 11.2% expansion in domestic demand (-4.0% in 4Q16), with durable consumption (+18.7%) and government expenditure (+13.2%) leading the improvement. Gross fixed investment (+9.8%, after falling 20.8% in 4Q16) also aided in the recovery of activity, as machinery and equipment accelerated to 46.4% (from -35.4% in the previous quarter), while construction added a sixth consecutive quarter of sequential contraction. Finally, net exports subtracted 9.6 p.p. from the annualized headline quarterly growth rate. Once inventories are excluded, GDP contracted 4.3% qoq/saar in 1Q17 (-2.1% in the previous quarter), signaling the headline recovery could be short-lived. 
  • We believe the composition of growth implies the economy remains structurally weak. Following this publication, we have downgraded our growth forecast for this year to 1.6%, from 1.8%, stable from 2016. A weakening labor market will be less supportive of growth going forward and public consumption will likely decelerate in coming quarters. Meanwhile, as the mining strike has come to an end, higher copper prices would help improve net exports, pulling growth up during the remainder of the year. Full Report
  • Chile’s current account deficit increased in 1Q17, affected by temporary factors, but remains at a low level. In 1Q17, the current account recorded a USD 1.0 billion deficit, larger than the market’s USD 0.8 billion deficit forecast and our USD 0.7 billion call. The deficit was also greater than the USD 0.4 billion recorded one year ago. The deterioration from 1Q16 is partly due to the impact the extended mining strike had on copper exports, while imports were lifted by recovering oil prices and the elevated consumption performance. Additionally, a larger income deficit was possibly led by improving mining profits for foreign companies as commodity prices recover. As a result, the rolling-4Q current account deficit rose to USD 5.0 billion (1.9% of GDP), from USD 3.6 billion in 2016 (1.4%). Our own seasonal adjustment shows the current account deficit increased at the margin, to 3.4% of GDP (0.9% in 4Q16). The foreign direct investment of USD 2.5 billion in 1Q17 was the lowest quarterly direct investment into Chile since 2Q13 (USD 1.1 billion), and down from the USD 3.9 billion in 1Q16. The majority of the investment in the quarter was dedicated to energy and industry.
  • We expect the current account deficit to retreat in the remainder of the year as internal demand stays weak and supply shocks affecting exports fade. Hence, we see Chile’s current account deficit broadly stable around the 1.4% recorded in 2016. With internal demand likely to show some recovery next year, a widening to 1.7% is expected. Full Report
COLOMBIA
  • Imports grew in 1Q17 for the first quarter since 4Q14, but recovering export commodity prices meant that the trade deficit continues to correct. The trade deficit came in at USD 726 million in March, broadly in line with market consensus and our forecast of USD 780 million. The deficit is smaller than the USD 1.1 billion recorded one year ago. This led to a trade deficit of USD 2.2 billion in 1Q17 (USD 3.5 billion in 1Q16), resulting the rolling 12-month trade deficit narrowing to USD 10.1 billion from USD 11.5 billion in 2016 (USD 15.9 billion in 2015). The recent narrowing is explained by an energy balance surplus that is growing by more than the rise in the non-energy balance deficit. At the margin, the trade deficit widened as capital and industrial import s accelerated. The annualized trade deficit (using our seasonal adjustment) increased to USD 9.2 billion in the quarter, from the USD 7.8 billion deficit estimated for 4Q16. In the month, total exports rose 37.9% year over year (15.6% in February), with coal coffee and oil exports leading the charge. In 1Q17, exports increased 31.4% year over year (13.7% in 4Q16). This is the highest moving quarter annual increase since the quarter ending in January of 2012, as commodity prices recover. Likewise, imports increased 15.2% year over year in March (5.4% previously), resulting in a 7.0% rise in 1Q17 (-8.4% in 4Q16). We expect the current account deficit to narrow this year (relative to 2016), due to weaker internal demand and higher terms of trade, to 3.6% of GDP, from 4.4% of GDP last year. Full Report
Market Developments 
  • GLOBAL MARKETS: Markets remained uneasy amid political uncertainties in the US. Volatility gauges and high yield credit spreads oscillated down. The Fed funds implied probability of a rate hike in June went back up to 97.5% from 82.5% as of Wednesday (May 17). Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities were mixed in the session. Oil prices increased at the margin (WTI: +0.57% to USD 49.35/bbl) while metals (copper: -0.53%; iron ore: -2.98%) and soybean (-3.18%) fell. In LatAm FX, all currencies under our coverage depreciated. The MXN (-0.29% to 18.84/USD) was affected by the BRL’s volatility, but later in the session recovered after Banxico hiked, as we expected (see Macro Backdrop). The COP weakened 0.96% to 2,926.46/USD and the CLP posted losses of 0.89% to 675.16/USD. At last, the BRL sold off on political uncertainties, closing at 3.3758/USD (-7.01%). After opening, the exchange traded USDBRL futures hit the circuit break limit of 6% weakening to the previous day closing price. Still in the morning, the exchange made a one-off increase of this limit to 9% (3.4180/USD). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads for the 5-year tenor were mixed in LatAm. Mexican spreads decreased 1bp to 120bps while Chilean spreads stood flat at 74bps. CDS in Colombia inched up 1bp to 133bps. Country risk in Brazil went up to the highest level since early January, to 264bps (+58bps). External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian rates sold off with DI futures testing the circuit breaks upside limits. The Jan-19 widened 160bps to 10.41%. In fact, the exchange temporarily expanded the oscillation boundaries for the DI futures contracts. For the first 3 contracts, the limits went to 80bps (from 60bps). From 3 to 6 months, they went to 100bps (from 75bps). From 6 to 9 months, they went to 110bps (from 85bps). From 9 months to 1 year, they went to 125bps (from 95bps). From 1 to 3 years, they went to 160bps (from 120bps). Finally, for maturities longer than 3 years, they went up to 180bps (from 135bps). Brazil Rates Tracker
  • LOCAL RATES - Mexico: Short Mexican yields widened after Banrep delivered a 25-bp hike, in line with our call but surprising the market (see Macro Backdrop). In TIIE swaps, the 1-year increased 13bps to 7.38% and the 5-year went up 12bps to 7.26%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields traded range bound. In Camara swaps, while short rates inched up 1-2bps (9-month: +1bp to 2.54%) the rest of the curve was broadly flat (5-year: at 3.47%). Chile Rates Tracker In Colombia, rates were also mixed at the margin. In IBR Swaps, the 18-month went down 1bp to 5.23% and the 5-year stood flat at 5.40%. Colombia Rates Tracker

Friday Events

  • In Brazil, industrial business confidence (CNI) for May will come through. We expect the current upward trend to continue. 
  • In Colombia, the national statistics authority will publish the supply-side breakdown of GDP growth for 1Q17. Based on activity indicators for the quarter, we estimate activity fell 0.1% from the previous quarter, resulting in annual growth of 1.4%, down from the 1.6% in 4Q16. Then, the March activity coincident indicator (ISE) will be published. Recent indicators reaffirmed that the economy was weak in the first quarter of the year. In the previous month, ISE grew a mild 0.3% year over year. 

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa


Macro Report

CHILE – Monetary policy meeting: Earlier than expected cut likely ends current cycle 

The central bank of Chile surprised most in the market by cutting the policy rate by 25 basis points for a second consecutive month to 2.5%. The cut came earlier than we were expecting – we believed the cut would only be implemented next month – and for nearly two-thirds of the market, according to Bloomberg as well as the majority in both central bank surveys prior to the meeting. Nevertheless, the lowering of the policy rate is in accordance with our call from late last year of a 100bp easing cycle from the 3.5% starting point. In line with the view that the current cycle has ended (at least in short-term) is the removal of the easing bias in the press release communicating the decision. Hence, it is unlikely that the upcoming Inflation Report forecast scenario includes guidance towards lower rates.

In spite of the recent increase in volatility in international markets, the central bank views the financial conditions as favorable, aiding a scenario of higher global growth. Domestic inflation has remained stable, while the inflation expectations for the relevant monetary policy horizon are at the 3% target. The 1Q17 GDP figures reflected activity to be in line with the central bank’s baseline scenario (GDP growth: 1.0%-2.0% for this year), with private consumption stable amid the evolvement of the labor market.

Our baseline scenario considers no further easing, while the start of a normalization process is likely by yearend 2018 as internal demand recuperates. However, activity is weak and the composition of the 1Q17 growth (0.1% year over year) hints that the risk of further weakening ahead is not negligible. If this scenario materializes, additional rate cuts later in the year are a possibility.

 Vittorio Peretti

 



< Back