Itaú BBA - Brazilian rates stood well behaved despite fiscal targets revision

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Brazilian rates stood well behaved despite fiscal targets revision

August 16, 2017

Brazilian yields had a muted reaction to the fiscal targets’ change (see Macro Backdrop) announced on Tuesday night.

With information available until 6:30pm Brasilia time


  • Brazilian yields had a muted reaction to the fiscal targets’ change (see Macro Backdrop) announced on Tuesday night. The economic team proposed a series of fiscal enhancing measures to be debated in Congress (see Macro Backdrop). In addition, S&P took Brazil off the negative CreditWatch. In DI futures, the Jan-20 went down to 8.78% (-2bps). 
  • In Mexico, the curve bull flattened (1s7s: -3bps) as Treasuries narrowed after the weak US housing starts and the FOMC minutes. In TIIE swaps, the 5-year narrowed 4bps to 6.89%. 
  • In FX, the BRL (+0.56% to 3.1524/USD) and the MXN (+0.83% to 17.6607/USD) also posted gains on the back of the Fed’s communication. Andean markets were closed by the time the minutes were released. 
Macro Backdrop

  • According to the IBGE’s monthly services survey (PMS), services sector real revenue rose 1.3% mom/sa in June, following a 0.5% gain in May. The year-over-year growth came at -3.0%, above consensus (-3.9%) and our forecast (-3.5%). The positive headline is consistent with industrial production and other monthly indicators advancing in June as the economic recovery continues to become more widespread. 9 out of 12 activities showed positive growth, so the diffusion of activities came in line with the strong headline. 
  • The central government deficit target was revised upward by BRL 20 billion to a deficit of BRL 159 billion (or -2.4% of GDP) for 2017, and by BRL 30 billion also to a deficit of BRL 159 billion (or -2.2% of GDP) for 2018. The 2017 revision was triggered by uncertainties on extraordinary revenues and the feasibility of a large budget cut. The 2018 revision, by its turn, reflected slower growth and inflation, a limited scope for tax hikes or measures that rely on Congress approval, cautiousness on extraordinary revenues forecasts and unwillingness of keeping discretionary spending at very low levels. The government proposed BRL 14.5 billion in measures to increase its revenues and help to comply with the new target and BRL 6 billion in personnel spending measures. With projected expenditures matching the constitutional spending ceiling, any positive surprise in the extraordinary revenues agenda or in the GDP growth will turn automatically into a better primary result in 2018. Full Report Below
  • Standard and Poor’s affirmed Brazil’s BB sovereign rating and removed it from CreditWatch, but kept the negative outlook. In keeping the rating, the agency cited that “the economy appears to have stabilized despite fluid politics, Congress passed a labor reform in July, and the government remains committed to advancing some pension reform, containing expenditure growth to minimize deviation from its primary fiscal targets, and advancing its active microeconomic reform agenda. However, according to S&P, the negative outlook “reflects ongoing political challenges and risk of a downgrade over the next six to nine months – given Brazil’s high and rising debt burden – should Congress fail to advance legislation that begins to reduce Brazil’s fiscal rigidities”. 
  • The TLP (new Long Term Interest Rate) report was read in the joint commission (Lower House and Senate) built to discuss this topic. According to Broadcast, the Committee Chair, Senator Lindbergh Farias, announced voting in the commission would take place on August 22. 
  • Macro Vision: we raised our 2Q17 GDP forecast to 0.0% qoq/sa from -0.2% qoq/sa. The increase is a consequence of stronger data in June. Positive surprises include industrial production, retail sales, service real revenues and the labor market. In our assessment, 2Q17 was marked by stronger underlying growth than we had forecast for the GDP headline. Simulations suggest that the result will be revised upwards at the time of next quarter’s GDP release. Full Report


  • Activity posted a mild recovery in 2Q17, but remains weak as the economy continues to adjust to the terms of trade shock. Activity increased 1.3% year-over-year in 2Q17, between  market consensus (1.2%) and our estimation (1.4%). The performance is an improvement from the upwardly revised 1.2% in 1Q17 (1.1% initially), but failed to prevent a slowdown in the rolling-4Q growth rate to 1.3% (1.6% in 1Q17; 2.0% in 2016). Activity in the quarter was led by financial services (+3.9% yoy vs. 4.3% in 1Q17) and social services (+3.0% vs. 2.9% in 1Q17), while manufacturing (-3.3% vs. +0.3% in 1Q17) and mining (-6.0% vs. -9.3% in 1Q17) dragged activity down. Mining hampered total natural resource related activity, offsetting the positive contribution from agriculture (4.4%, after 7.8% in 1Q17), a sector that has been favored by diminishing negative effects from last year’s El Niño weather phenomenon. 
  • Activity will likely show some recovery in the second part of the year. We expect growth of 1.6%, down from 2.0% in 2016, but acknowledge downside risks. As activity stays at low levels, Banrep will likely implement additional rate cuts. We expect a 25-bp rate cut to 5.25% later this month, with further cuts early next year. In all, lower inflation, the ongoing monetary-easing cycle, and higher average oil prices compared to 2016 will favor growth going forward. Full Report
  • Inflation expectations in the month of August remained broadly stable, according to the central bank’s monthly survey. The survey shows that the 2017 yearend inflation expectation dropped to 4.15% (4.30% in the June survey; Itaú: 4.2%), however, the remaining horizons were unchanged. The 1-year horizon expectation sits at 3.6%. The 2018 inflation expectation is at 3.5% for the fourth consecutive month (Itaú: 3.8%), while the 2-year horizon inflation expectation also stayed at 3.5%. The core inflation expectation measure (excluding food prices) was also unchanged at 3.6% for a 1-year horizon and 3.2% for two-years ahead. 
  • Meanwhile, a 25-bp rate cut to 5.25% is expected this month (in line with our call), before pausing until the first month of 2018. The policy rate is still seen reaching 4.5% in May next year (broadly in line with our baseline scenario). The central bank cut the policy rate by 25bps last month to 5.5% as inflation continued to fall. However, several board members have indicated that the space for rate cuts has narrowed. We only see one further rate cut this year as favorable base effects for inflation fade in 2H17. 
  • In July, consumer confidence completed 19 consecutive months in pessimistic territory (below 0), but there are some signs of improvement. Think-tank Fedesarrollo’s consumer sentiment index came in at -9.5 points, up from the -14.9 points one year before (June: -11.7). Compared to the previous month and July 2016, there was an improvement in both divisions (expectations and current economic conditions). Consumer expectations are less negative (-7.3 vs. -11.5 one year ago), due mainly to an optimistic outlook on the economic conditions of the Colombia over the next 12 months (+13.1 vs. -18.3 in July 2016). Meanwhile, the current economic conditions evaluation sits at -12.7 points (-19.9 one year ago) as respondents hold a less gloomy evaluation on whether it is an opportune time to purchase household appliances. In line with a confidence improvement, a majority of respondents are willing to purchase real estate, which was not the case one year ago nor in June. A more stable COP, low inflation, and a less tight monetary policy will likely aid a gradual improvement of consumer confidence in the months ahead and lead to better consumption performance.
Market Developments 
  • GLOBAL MARKETS: Treasuries narrowed (5-year: -4bps to 1.79%) after the FOMC minutes. The Fed signaled gradual hikes remain appropriate, but evaluating next inflation prints to decide on the next hike. Overall, a December hike is still alive, but upcoming inflation prints will be key to watch. The Fed funds futures implied probability of another rate hike in 2017 fell to 39% from 44% as of Tuesday. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities (CRB futures: -0.54%) were dragged by agriculture and energy in the session. Oil prices (WTI: -1.59% to USD 46.94/USD) fell as EIA’s weekly report showed a rise in US crude production last week. On the other hand, metals outperformed as iron ore increased 1.35% and copper +2.88%. On a weak USD day (DXY: -0.37%), most LatAm FX (+0.56%) posted gains. By the time of writing, the MXN gained 0.83% to 17.6607/USD. The BRL appreciated 0.56% to 3.1524/USD and the CLP closed at 645.38/USD (+0.60%). At last, the COP slightly depreciated to 2,969/USD (-0.10%). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm credit spreads traded range bound in the session. Mexican and Chilean spreads stood at 106bps and 62bps, respectively. Meanwhile, Colombian country risk widened 2bps to 130bps. Finally, Brazilian CDS inched down 1bp to 200bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian yields had a muted reaction to the fiscal targets’ change (see Macro Backdrop) announced on Tuesday night. In DI futures, the Jan-18 fell 2bps to 8.12% and the Jan-20 went down to 8.78% (-2bps). Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve bull flattened (1s7s: -3bps). In TIIE swaps, the 1-year went down 1bp to 7.30% and the 5-year narrowed 4bps to 6.89%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields fell 1-2bps as markets reopened after Tuesday’s holiday. In Camara swaps, the 1-year fell 2bps to 2.38% and the 7-year inched down 1bp to 3.74%. Chile Rates Tracker In Colombia, long rates marginally fell. In IBR swaps, the 1-year was flat at 4.95% and the 5-year inched down 1bp to 5.54%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, the BCB will release its monthly activity index (IBC-Br) for June (Thu.) and CNI will release its industrial business confidence for August (Fri.). 
  • In Chile, the BCCh will hold its August monetary policy meeting (Thu.). With July’s inflation coming in slightly above market expectations and activity not deteriorating further, we expect the board to keep the policy rate stable at 2.5% in another split decision. Of interest would be whether the communication announcing the decision re-introduces an easing bias. We currently expect two additional 25-bp rate cuts this year. Moreover, the central bank will publish the National Accounts data for the second quarter of the year (Fri.). At the margin, we expect GDP to gain 0.7% from 1Q17, leading to annual growth of 1.0% year over year (0.1% in 1Q17). Then, the central bank will also publish the 2Q17 current account balance (Fri.). We expect a USD 1.2 billion deficit, up from the USD 1.0 billion deficit in 2Q16, mainly on the back of a smaller trade balance surplus (USD 1.3 billion in 2Q17, after USD 1.7 billion in 2Q16) as mining production gradually recovers from the 1Q17 strike. 
  • In Colombia, Banrep will present its quarterly inflation report (Fri.). The central bank will likely implement a downward revision to growth forecasts for this year (currently 1.8%), while confirm the expectation that inflation will accelerate through the remainder of the year. Meanwhile, the report will likely also indicate that room for further easing is narrow, a message already being communicated by various board members. 

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

For details on Brazilian markets, refer to our Handbook - First edition.

Today's editors: Eduardo Marza, Pedro Correa

Macro Reports

Brazil: Government announces new fiscal target for 2017 and 2018

Bottom-line: The central government primary deficit targets were revised upward by BRL 20 bln to BRL -159 bln (or -2.4% of GDP) in 2017, and by BRL 30 bln to BRL -159 bln (or -2.2% of GDP) in 2018. The 2017 revision was triggered by uncertainties on extraordinary revenues and the feasibility of a large budget cut. The 2018 revision, by its turn, reflected slower growth and inflation,  a limited scope for tax hikes or measures that rely on Congress approval, cautiousness on extraordinary revenues forecasts and unwillingness of keeping discretionary spending at very low levels. The government proposed 14.5 BRL bln in measures to increase its revenues and help to comply with the new target and 6 BRL bln measures in personnel spending that will allow discretionary spending to regain some  of the margin lost after this year’s large cuts, even with a lower spending limit coming from falling inflation. With expenditures set on purpose at the ceiling, any positive surprise in the extraordinary revenues agenda or in the GDP growth will turn automatically into a better primary result in 2018.    

The 20 BRL bln  2017 revision to a -159 BRL bln deficit (-2.4% of GDP)  followed 10 BRL bln disappointment in revenues (around 8 from extraordinary and 2 from recurring)  and the need to reduce the current budget cut in other 10 BRL bln. Specifically, as announced by the economic team, the triggers were the  recognition that the Refis/PERT program should be modified by Congress, reducing its current expected collection (from 13 to something around 5-10 BRL bln), extra 1 BRL bln frustration related to the repatriation bill, 2 BRL bln from July’s tax collection and the need to reduce the current “impracticable” budget freeze of BRL 45 bln in around BRL 8-10 bln. The revision came in line with our current forecast of a BRL -157 bln deficit (-2.4% of GDP) for this year. 

For 2018, the 30 BRL bln revision to an equal -159 BRL bln deficit (-2.2% of GDP) came from a 42 BRL bln frustration in net-revenues and 2 BRL bln from higher expenses related to the recognition of the impact on primary results of the FIES program that were only partially offset by 14 BRL bln in measures on the revenue side. Lower growth and inflation for this and next year, compared to government April’s scenario led to a large disappointment on revenues. At the same time, the recognition of primary spending with the FIES program led to an increase in spending of 2 BRL bln. This came despite the effect of the lower inflation to the spending ceiling: in April, the ceiling was around BRL 1,374 bln, but expenditure was set slightly below that at 1,370 BRL bln. Now, the effective ceiling would have been set 10 BRL bln lower due to the downside surprise on inflation, but was increased by 8 BRL bln to account for the FIES program expenses (hence, being at 1,372 BRL bln for next year). All else equal, this would mean a decline of 6 BRL bln in discretionary expenditure , but announced measures on personnel spending  will replace the need for this cuts. Finally, announced measures on the revenue front are related to taxing some closed investment funds (6 BRL bln), another try for the reduction in the payroll tax exemption (4 BRL bln),  the maintenance of current rules for exporters at the Reintegra program (2.6 BRL bln) and the rise in contributions of public personnel to their pensions (2 BRL bln).

Also, government announced measures that aim reducing public personnel spending by 6 BRL bln next year (and by almost 20 BRL bln in the following 5 years). These measures didn’t translate into a better primary target next year as they were taken to guarantee some growth  in discretionary spending, even with the above-mentioned spending ceiling lower base.  Importantly, this rise doesn’t mean that the ceiling is to be breached in 2018, but only a government will to recovery some margin in the discretionary expenditure after strong budget cuts in 2017. This line will actually grow 12% y/y in real terms next year. We continue to see difficulties regarding the compliance with the ceiling climbing significantly in 2019. Regarding the measures, for the short term, the government announced a one-year delay of scheduled pay rises for some public workers (5 BRL bln) and the effective application of the wage ceiling for public workers (1 BRL bln). For the medium term, government proposed to restructure public careers, which could have an almost 20 BRL bln accumulated 5 years impact, starting in 2019. New public workers will have a lower wage that will rise more gradually to each career’s cap, according to amount of years worked.

Government signaled that was cautious on its forecasts for extraordinary revenues for 2018. The economic team said that included only 14 BRL bln related to new concessions, being 6 BRL bln from airports and 8 BRL bln from the energy sector. There are other extraordinary revenues that could take place next year (the most important, but also more controversial being the “cessao onerosa” discussion with Petrobras), but the government preferred to leave them out of the budget for now.   

While most of the measures presented today still depend on Congress approval (see table below), with expenditures set on the constitutional limit, any surprise on revenues whether from this agenda or from the chance of a higher GDP growth (for instance, we expect 2.7%) will be true upsides for the primary result of the year. Actually, this could be seen as an strategy to use short-term primary targets only to signal that there will be no further deterioration in primary results, while turning the spending ceiling the most important fiscal rule, which will guarantee that eventually Brazil will return to a primary surplus.

Pedro Schneider

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