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Brazilian rates end a volatile week on a high note

April 7, 2017

Yields in Brazil narrowed after the soft US Payroll and the confirmation of the lowest 1Q inflation since the Real Plan.

With information available until 6:30pm Brasilia time


  • Yields in Brazil narrowed after the soft US Payroll and the confirmation of the lowest 1Q inflation since the Real Plan. Rates trimmed gains later in the session as the government announced a change to 2018 primary balance target (see Macro Backdrop). In DI Futures, the Jan-18 decreased 4bps to 9.76% while the Jan-21 fell 9bps to 9.91%.
  • The Mexican curve bear flattened (1s10s: -3bps) on higher-than-expected CPI figure (see Macro Backdrop). In contrast, Chilean yields narrowed 3-4bps past the 1-year as inflation came slightly below expectations (see Macro Backdrop). 
  • LatAm FX were mixed. The CLP posted gains of 0.15% to 655.66/USD while the MXN outperformed the majors, trading at 18.67/USD (+0.44%). On the other hand, the BRL slightly depreciated to 3.1464/USD (-0.10%) and the COP was the regional laggard, closing at 2,862.73/USD (-0.24%).

Macro Backdrop

  • IPCA rose 0.25% in March, in line with the median of market expectations. The index came in slightly below our call (0.27%) and matching the median of market expectations. In 1Q17, the IPCA climbed 0.96%, down significantly from 2.62% in 1Q16. According to census bureau IBGE, it was the lowest first-quarter reading since the introduction of the Real Plan, in 1994. The year-over-year change in headline inflation decelerated to 4.57% (February: 4.76%). Breaking down by product groups, the largest upward contributions during the month came from housing (0.18 p.p.), food and beverages (0.09 p.p.), and healthcare and personal care (0.08 p.p.), followed by personal expenses (0.06 p.p.) and education (0.04 p.p.). On the other hand, the transportation group posted a 0.86% drop, with an impact of -0.16 p.p. on monthly inflation, due to lower fuel costs. Gasoline prices fell 2.1% and ethanol prices tanked 5.1% in March. As for core inflation measures, the average of the three most used ones (smoothed trimmed means, double weight core and core inflation by exclusion) rose 0.32% in March (February: 0.39%). Thus, the year-over-year rate decelerated to 5.6% (5.7% y/y in the previous month).Full Report
  • Our preliminary estimate for the IPCA in April stands at 0.13%, prompting another decline in the year-over-year change to 4.1%. The greatest upward contributions will likely come from healthcare and personal care (led by medication prices and health insurance premiums) and the food group. On the other hand, housing is set to provide a substantial negative contribution of -0.18 p.p., due to the decline in electricity bills. The result will reflect the return of undue charges tied to the Angra 3 nuclear power plant, which will more than offset the effect caused by the red mode in the tariff flag system, triggered in early April. However, the hefty downward effect on electricity related to Angra 3 is temporary and will be mostly given back in May. 
  • The government announced that it will send the 2018 Budgetary Guidelines Law with a consolidated public sector primary deficit target of BRL 131 billion (1.9% of GDP). Regarding the central government, the deficit target of BRL 129 billion (-1.8% of GDP) was slightly worse than our estimated deficit of BRL 120 billion (-1.7% of GDP). This is a shy improvement compared with the targeted deficit of BRL 139 billion in 2017, heralding a slow narrowing of the primary deficit even with the return of economic growth and the spending ceiling in effect. 
  • Mexico’s inflation continues on an upward trend, driven by the lagged effects of exchange rate depreciation (even though the currency has been strengthening since late January). The CPI posted a 0.61% m/m variation in March - above our forecast (0.54%) and market expectations (0.58%) - largely explained by tradable prices (core goods), which increased 0.78%. The other culprit was the rebound of agricultural prices, which increased 2.2% m/m (after two months of abnormal declines) and contributed 20bps to the CPI print. Within services, we highlight that certain prices which are sensitive to exchange rate variations, such as airfares (12.2%) and tourism packages (6.5%), continue posting high variations. Gasoline prices (-1.3%) and mobile telephone services prices (-1.4% m/m), in contrast, exerted downward pressure. The headline measure rose to 5.35% in March (February: 4.86%) - now standing at its highest level in almost eight years - further above the upper bound of the tolerance range (2%-4%) around the Central Bank’s 3% target. Core inflation increased to 4.48% from 4.26% during the same period, with core goods (5.85%, previous: 5.39%) - proxy for tradables (and hence more sensitive to exchange rate depreciation) - showing an accelerating path.
  • The MXN has strengthened recently (15% from its weakest level in January), and with that there is lower upside risks for inflation this year. Given this exchange rate appreciation, the adjustment of relative prices which is pushing core goods higher will likely come to a halt eventually. We expect inflation to continue trending up until 3Q17, and then decrease to 5% by the end of 2017, driven by the strengthening of the MXN and weaker demand pressure. Full Report
  • Prices increased 0.4% from February to March, in line with the gain recorded one year ago. This was below our forecast and market consensus (both at 0.5%). Prices in the month were lifted by the seasonal adjustment to education fees (4.3% m/m, +0.4 p.p. of the headline variation). Food and non-alcoholic beverage inflation was the other division lifting prices in the month, however, it rose less than we expected and was the principal reason for our downside surprise. Meanwhile, as the summer season ended, transportation prices declined 1.2% from February resulting in 0.2 p.p. drag to the headline variation. The non-tradable component increased 0.7% from February (March 2016: 0.8%), while tradable goods prices gained 0.1%, in line with last year. Excluding food and energy, prices rose 0.4% in the month (March 2016: 0.5%). Annual inflation was stable at 2.7%, completing six months below the 3% target. Tradable and non-tradable inflation remained broadly stable at 2.3% and 3.3%, respectively. Inflation excluding food and energy prices also stayed low and steady at 2.2%, while other core inflation measures are also hovering around the lower bound of the range around the target. 
  • We expect inflation to stay low for the remainder of the year (2.8% yearend), allowing the central bank to increase the monetary stimulus. Notwithstanding the weak activity and moderate inflation, we see the next cut coming later in the 2Q17, as the board is adopting a cautious approach. In its 1Q17 IPoM, the BCCh signaled only one further 25-bp rate cut in its baseline scenario, whereas we see the policy rate ending this year at 2.5% (currently: 3.0%). Full Report
  • The USD 290 million surplus in March – above our call (USD 50 million) and market consensus (USD 150 million) - led to a lower trade balance surplus in 1Q17 compared to one year ago. In the month, copper exports contracted given the labor strike at Chile’s largest mine. As a result, the rolling 12-month trade surplus narrowed to USD 4.3 billion (2016: USD 5.3 billion), but still reflects low external vulnerabilities. Our seasonally adjusted series shows that, at the margin, the trade balance dropped to USD 1.0 billion (annualized) in 1Q17, from the USD 6.9 billion recorded in 4Q16. Total imports grew 12.2% y/y in 1Q17, up from the 0.1% drop in 4Q16, led by the 30.2% rise in durable consumption goods imports (mainly vehicles). Total exports increased 4.5% y/y in the quarter (4Q16: 9.6%), with improved industrial exports being offset by weaker mining exports. Copper exports fell 0.6% from last year (4Q16: +7.6%) as quantity declined amid the 43-day strike at the country’s largest copper mine.
  • We expect mining exports to recover ahead as copper export volumes rebound and prices will be, on average, above last year’s level. We also believe internal demand will remain weak this year and so Chile’s current account deficit is set to remain low. We estimate a current-account deficit broadly stable from the 1.4% of GDP recorded last year. Full Report
  • The minutes from the central bank’s March monetary policy meeting show that the persistence of core inflation at elevated levels means most board members see no room to increase the pace of rate cuts. The March decision to lower the policy rate by 25-bp to 7.0% split the board into three camps. Only one of the six board members believed that it was worth holding the policy rate at 7.25% to guarantee that inflation converges quickly to the 2%-4% tolerance range in a bid to prevent credibility loss. Meanwhile, finance minister Mauricio Cardenas is committed to jump-starting the economy. Cardenas voted for a 50-bp rate cut, citing the benefit of lower rates in preventing an excessive economic slowdown. The remaining four members note the declining trend of inflation expectations, the recent weakness of activity, low credit growth and the still restrictive interest rate as justifying factors behind the decision to cut the policy rate. However, some in this group acknowledge that the simultaneous risk of an excessive activity slowdown and more persistent inflation has increased. 
  • Following this meeting, the March data will not ease the concern over sticky inflation. Headline inflation continued to decline swiftly, but core measures remained stable and relatively elevated. As it is not clear if the unfavorable behavior of these inflation metrics at the margin is still due to VAT increase (which is one-off) or inertia (the central bank’s concern), the monetary authority is unlikely to step-up the pace of rate cuts in the short-term. Therefore, we expect the board to continue with the 25-bp rate cut pace at this month’s meeting, taking the policy rate to 6.75%. We see additional easing through the remainder of the year (our forecast is 5.50% by yearend). Full Report

Market Developments 

  • GLOBAL MARKETS: The US Non-Farm Payroll print came in 98 thousand, below expectations (180 thousand), but not as bad as the headline suggests. The surprise can be largely be explained by two factors: weather sensitive industries (-30 thousand) and the decline in retail trade employment (-30 thousand). Despite the decline in the unemployment rates, the wage inflation rose 0.2% m/m and 2.7% y/y, remaining at a gradual pace of acceleration. In sum, job creation is likely to return to trend growth in the next months, consistent with a modest GDP growth. Nevertheless, Treasuries widened (5-year: +6bps to 1.92%) as Fed’s Dudley has emphasized that any pause in the interest rate normalization process due to potential balance sheet reduction would be brief.
  • CURRENCIES & COMMODITIES: Commodities were mixed as oil prices increase (Brent: +0.62% to USD 55.23/bbl) on geopolitical concerns and metals posted losses (iron ore: -3.45%). In LatAm FX, currencies under our coverage were mixed. The CLP posted gains of 0.15% to 655.66/USD while the MXN outperformed the majors, trading at 18.67/USD (+0.44%). On the other hand, the BRL slightly depreciated to 3.1464/USD (-0.10%) and the COP was the regional laggard, closing at 2,862.73/USD (-0.24%). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm Credit spreads for the 5-year tenor were broadly stable in the session. CDS in Brazil and Chile were flat at 225bps and 73bps, respectively. On the other hand, Colombian spreads inched down 1bp to 133bps and Mexican country risk decreased 2bps to 129bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian yields ended the week on a high note owing to the soft US Payroll and the confirmation of the lowest 1Q inflation since the Real Plan (see Macro Backdrop). In DI Futures, the Jan-18 decreased 4bps to 9.76% while the Jan-21 fell 9bps to 9.91%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve bear flattened (1s10s: -3bps) on higher-than-expected CPI figure (see Macro Backdrop). In TIIE swaps, the 1-year went up 3bps to 7.18% and the 5-year inched up 1bp to 7.25%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields narrowed 3-4bps past the 1-year as inflation came slightly below expectations (see Macro Backdrop). In Camara swaps, the 1-year fell 4bps to 2.71% and the 5-year went down to 3.44% (-4bps). Chile Rates Tracker In Colombia, yields traded range bound. In IBR swaps, while the 1-year inched down 1bp to 5.76%, the 10-year stood flat at 6.11%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, the Central Bank’s Monetary Policy Committee (Copom) meets again (Tue. /Wed.). We assess that the Committee will carry out a 100-bp interest rate cut, bringing the Selic rate to 11.25%. Regarding the communiqué, we expect the Committee to signal that the extension of the easing cycle will depend on forecasts and inflation expectations, but also on estimates of the structural interest rate of the Brazilian economy. Then, the key releases on economic activity will be February’s retail sales numbers (Wed.) and the Service Sector Survey (PMS) (Thu.). We forecast a 0.1% m/m increase in core retail, whereas the broad segment, which includes vehicle sales and construction material, will probably grow 2.2% m/m on stronger vehicle sales. Moreover, IBGE will release the monthly update of its Systematic Survey of Agricultural Production (Tue.). Given recent crop upgrades for several agriculture analysts, the new survey may further increase the contribution of agricultural production to 1Q17 GDP. In addition, traffic of heavy vehicles (ABCR) and paper cardboard dispatches (ABPO) for March, two material coincident indicators for industrial production, may be released throughout the week. Our preliminary forecast for March’s industrial production stands at -0.7% m/m. Finally, the government will submit the Budgetary Guidelines Law (LDO), which establishes spending targets for the federal government (deadline Thur.).
  • In Mexico, the statistics institute (INEGI) will publish February’s industrial production (Tue.). We expect a 1.5% y/y contraction (January: -0.1%) based on coincident indicators. Then, the National Association of Department Stores and Supermarkets (ANTAD) will announce March’s same-store-sales (Tue.). We expect ANTAD sales to grow 3.8% y/y (February: 2.7%). Moreover, the Central Bank will publish the minutes of March’s monetary policy meeting (Wed.). The minutes will be interesting because they will shed more light about the arguments of the board to opt for more gradual tightening.
  • In Chile, the BCCh will hold its monthly monetary policy meeting (Thu.). In spite of the weak activity and moderate inflation registered in the lead up to the meeting, we expect the central bank to leave the policy rate unchanged at 3.0%, as a cautious approach is adopted.

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For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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