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Brazilian rates tighten as coincidents herald another IP drop

May 9, 2017

Brazilian yields narrowed as coincident indicators suggest the industrial production weakness will extend into 2Q17.

With information available until 6:30pm Brasilia time

Highlights

  • Brazilian yields narrowed as coincident indicators suggest the industrial production weakness will extend into 2Q17 (see Macro Backdrop). Also, the social security reform special committee will likely conclude voting the amendments still on Tuesday. The next step is to vote the bill on the Lower House floor. In DI futures, the Jan-18 fell 4bps to 9.36% and the Jan-21 went down 7bps to 9.88%. In Mexico, the curve curve bear flattened as inflation measures topped even the highest forecasts (see Macro Backdrop). In TIIE swaps, the 1-year went up 6bps to 7.36% and the 10-year widened 3bps to 7.55%. 
  • In LatAm FX, most currencies under our coverage appreciated. However, on the back of lower oil prices, the COP posted losses of 0.29% to 2,969.75/USD. Then, the CLP posted mild gains of 0.05% to 677.90/USD and the MXN is trading 0.18% higher to 19.17/USD. The BRL ranked the top performer among the major currencies, closing at 3.1883/USD (+0.31%).

Macro Backdrop

BRAZIL
  • Coincident indicators (ABPO) consistent with 0.3% mom/sa decline in industrial production. Paper cardboard dispatches (ABPO) fell 1.6% mom s.a. in April (our seasonal adjustment), down 4.3% yoy. It is one of the two most important coincident indicators for industrial production (the other is traffic of heavy vehicles). The result is consistent with yet another monthly decline in industrial production in April: we lowered our forecast to -0.3% mom/sa (from: +0.1%). The drop follows a 1.8% mom/sa decline in March and extends the industrial production weakness into 2Q17. The incidence of holidays on weekdays and a strike on the last working day of the month may have distorted downward both the raw figure and the seasonally-adjusted data, as the X-12 algorithm fails to fully account for the different number of working days. Nonetheless, economic activity figures are showing renewed weakness on March/April after a brief improvement between December and February.
  • We increased our estimate of the Social Security reform’s fiscal impact to 70% from 66% of the original proposal. As a result, the savings accumulated over 10 years rose to BRL 530 billion from BRL 500 billion, compared to an impact of BRL 755 billion from the original proposal. Vis-à-vis 2025, this generates additional expenditure savings of 0.10 p.p. of GDP (total of 1.05 p.p. of GDP). Estimates do not include the savings with the public servant pension system.
  • The change is reflected in the way Social Security benefits are calculated. In the proposed reform, it was unclear whether the methodology would kept at benefits = 80% out of the largest contributions or whether it would be altered for the entire contributory record as defined in the rapporteur's report. The change reduces the average value of all new benefits above the minimum wage (pensions and benefits) and was, therefore, a way for the government to compensate for concessions on other points in the reform.
MEXICO
  • Inflation came in high in April, pressured by the lagged effects of peso depreciation and a rebound of agricultural prices. The CPI increased by 0.12% month-over-month, above market expectations (0.06%) and our own forecast (0%). Monthly inflation is normally negative in April (the five-year median is -0.33% month-over-month), as the Federal Electricity Commission (CFE) introduces “summer tariffs”, which are lifted later in the year (October-November). In fact, electricity prices decreased by 13.4%, subtracting 34bps from monthly CPI inflation. However, this was more than offset by the increase of core goods (tradable) prices (up by 0.6%), a sharp rebound of agricultural prices (up by 1.9%), and the seasonality of the Easter holidays (which exerted upward pressure on service prices, such as air transport, tourism services, and food outside home). Annual headline inflation increased to 5.82% year-over-year (from 5.35% in March) further above the Central Bank’s target of 3.0%. Core inflation also increased, to 4.72% (from 4.48%) during the same period. Moreover, a diffusion index, which tracks the percentage of items in the CPI basket with annual inflation higher or equal to 4%, continues to increase (73% in April, up from 51% in December 2016).
  • We have increased our inflation forecast for 2017 to 5.4% (from 5%). In our baseline scenario, inflation would move down because of the lagged effects of peso appreciation (7% year-to-date, compared to the 19% depreciation observed in 2016) and, to a lesser extent, weaker activity. Tighter monetary policy will also be instrumental to contain inflation expectations. So far, inflation expectations have been increasing significantly for the short-term, but longer-term measures have recently stabilized. Full Report
Market Developments 
  • GLOBAL MARKETS: Equity markets were on the green as the dollar posted gains against DM peers (DXY: +0.53%). Likewise, volatility remained in low levels, US Treasuries widened (5-year: +2bps to 1.93%) and gold prices hit a 2-month low (-0.55%). Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities were mixed as oil prices fell and metals posted gains (iron ore: +2.17%, copper: +0.16%). Oil decreased (WTI: -0.52% to USD 46.19/USD) as EIA’s monthly Short-Term Energy Outlook report showed US output will average 9.31 million barrels a day in 2017 (up from 9.22 million projected in April), and rise yet again for 2018 to a record 9.96 million barrels a day (up from 9.9 million). In LatAm FX, most currencies under our coverage appreciated. However, on the back of lower oil prices, the COP posted losses of 0.29% to 2,969.75/USD. Then, the CLP posted mild gains of 0.05% to 677.90/USD and the MXN is trading 0.18% higher to 19.17/USD. The BRL ranked the top performer among the major currencies, closing at 3.1883/USD (+0.31%). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm Credit spreads for the 5-year tenor traded range bound in the session. CDS in Colombia inched up 1bp to 133bps. Then, Chilean spreads stood flat at 75bps. On the other hand, country risk in Mexico and Brazil both went down 1bp to 119bps and 214bps, respectively. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian yields narrowed as paper cardboard dispatches sales fell in April (see Macro Backdrop). Also, the social security reform special committee will likely conclude voting the amendments still on Tuesday. The next step is to vote the bill on the Lower House floor. In DI futures, the Jan-18 fell 4bps to 9.36% and the Jan-21 went down 7bps to 9.88%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve bear flattened as inflation measures topped even the highest forecasts (see Macro Backdrop). In TIIE swaps, the 1-year went up 6bps to 7.36% and the 10-year widened 3bps to 7.55%. Accordingly, breakevens also went up as the 5-year increased 5bps to 4.05%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields traded higher in the session. In Camara swaps, while short rates went up 2-3bps (1-year: +2bps to 2.60%), long widened 5bps on average (8-year: +5bps to 3.97%). Chile Rates Tracker In Colombia, the very front traded range bound while long widened substantially. In IBR Swaps, the 1-year stood flat at 5.28% and the 5-year increased 11bps to 5.37%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, IPCA consumer inflation for April will be released (Wed.). We forecast a 0.15% monthly rise, with year-over-year inflation decelerating to 4.1% from 4.6%. Moreover, the key releases on economic activity will be March’s retail sales figures (Thu.) and the Service Sector Survey (PMS) (Fri.). We forecast a 0.5% setback in core sales (month-over-month, seasonally adjusted), whereas the broad segment, which include vehicle sales and construction material, will likely decline 0.8% month-over-month. Moreover, IBGE will release the monthly update of its Systematic Survey of Agricultural Production (Thu.). Finally, traffic of heavy vehicles (ABCR) for April, relevant coincident indicator for industrial production, may be released.
  • In Mexico, the National Association of Department Stores and Supermarkets (ANTAD) will announce April’s same-store-sales (Wed.). We expect ANTAD sales to grow at a weak 2.5% year-over-year (from 4% in March). Finally, the statistics institute (INEGI) will publish March’s industrial production (Fri.). We expect a 1% year-over-year expansion (up from a 1.7% contraction recorded in February), helped by a positive calendar effect (from the Easter holidays, which last year took place in March). 
  • In Colombia, the monetary policy meeting minutes from April will be published (Fri.). At the meeting, the central bank once again surprised the market by implementing a larger than expected 50-bp rate cut, to 6.5%. The minutes will provide more indication on the thought process behind the more aggressive rate cut and what conditions will determine the pace of future rate cuts. Then, activity indicators for the month of March will be published (Fri.). In the month of February, activity indicators came in notably frail, consolidating activity’s weak footing at the start of the year. We expect industrial production to increase 2.2% year over year (-3.2% in February). Meanwhile, retail sales are likely to rise 2.0% in twelve months (-7.2% previously), as car sales improved.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa




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