Itaú BBA - Brazilian yields end the week on a high note

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Brazilian yields end the week on a high note

January 27, 2017

Brazilian rates staged a rally, amid a positive external environment and good news on inflation front (cut in gas prices, maintenance of green flag).

With information available until 6:30pm Brasilia time

Highlights

  • Brazilian rates staged a rally, as the narrowing of external yields added to good inflation news (cut in gasoline and diesel prices, maintenance of the green mode in the electric tariff flag system). In DI futures, the jan-21 tightened 9bps to 10.87%.
  • Colombian yields were narrowing prior to Banrep’s meeting (see Macro Backdrop). After the board stood on hold, yields at the very front end (3- and 6-month tenors) staged a correction. The curve is poised to flatten further on Monday.
  • Mexican assets paid back to the previous sessions’ losses. The MXN rallied (1.46% to 20.91/USD), reverting Thursday’s losses. In TIIE swaps, yields tightened by double-digit figures past the 3-year: the 5-year dropped 15bps to 7.60%.
  • The strong adjustment of Brazilian external accounts that took place in 2016 and the ongoing fiscal reforms debate contrast with idiosyncratic uncertainties weighing on Mexico, Turkey and South Africa. Such improvement in Brazilian fundamentals suggests the expected changes in external liquidity will have a diminished impact over the BRL’s volatility relative to other high-yielders. In our Monthly Strategy Report we argue that Brazilian rates will outperform peers on the new external enviroment.

Macro Backdrop

BRAZIL

  • Tax collection 3-year real decline is showing some relief at the margin. Tax collection came in at BRL 127.6 billion in December, a bit better than market expectation and our call (both at BRL 125 billion). This implies a 1.2% y/y real decline (previous: 0.1%) and significant improvement for the full quarter (4Q16: -1.6% y/y; 3Q16: -6.4% y/y). In 2016, the tax collections (excluding repatriation bill revenues) registered a 5.9% annual real decline (2015: -4.8%). We believe tax collection will have a gradual recovery in 2017 since its most relevant drivers (real wage bill and retail sales) will continue to underperform GDP. Our projections imply that around BRL 60 billion in non-recurrent revenues will be necessary to comply with 2017’s primary result target of a BRL 143 billion deficit (-2.2% of GDP) as we expect. Full Report Below
  • As expected, power regulator Aneel kept the green mode in the tariff flag system for February.
  • Construction confidence (FGV) increased 3.5% m/m in January, with rises both in current situation (2.4%) and expectations (4.2%). Although this data has low correlation with the other construction data, the result shows some stabilization trend at the margin, after 2 consecutive drops.
  • Gasoline (-1.4%) and diesel (-5.1%) prices at refineries were reduced. The impact on the IPCA inflation is small (at most -2 basis points).
  • Minister Meirelles and State Governor Pezão announced an agreement towards the fiscal recovery of Rio de Janeiro state. The regime has a timespan of 3 years and seeks to balance the projected deficits over the period (2017: BRL 26 billion; 2018: BRL 18.7 billion; 2019: BRL 17.7 billion). The timespan may be extended if it proves to be insufficient. Loans anticipating the privatization of a utilities state company and oil royalties will be used to pay delayed wages. The impact over the consolidated primary result tends to be neutral. New loans and debt renegotiation (impact of BRL 12.7 billion, according to the government) that would allow an increase in primary spending, will likely be offset by measures to increase revenue and reduce spending (impact of BRL 13.4 billion). Rio de Janeiro’s state debt is expected to fall below the 200% threshold of net recurring revenue mandated by the Fiscal Responsibility Law from 2018 onwards. Our preliminary estimates indicate that 2016’s debt level reached 220% of net recurring revenue and will fall to 190% in 2019, if the adjustment is made.
  • The BCB allotted USD 750 million in regular FX swaps. After closing, the BCB called a rollover auction of up to 14,000 contracts on January 30 (USD 700 million).

COLOMBIA

  • The unemployment rate inched up at the close of 2016 as the economy cooled. The unemployment rate ended 2016 at 8.6%, 1% higher than one year ago. In the final quarter of the year, there was an increase from 8.0% to 8.2% over the last year, resulting in an average unemployment rate of 9.2% in 2016 (2015: 8.9%). Adjusted for seasonal factors, the national unemployment ra¬¬te was broadly stable from 3Q16 at 9.1% in the quarter. Employment growth slowed to 0.4% y/y (0.7% in 3Q16), remaining near historical lows. In addition, job creation remains weak and primarily supported by self-employment, while there is a sustained rise in discouraged workers, also supporting the view that the labor market is loosening. The 65.4% participation rate came in 0.5 percentage points lower than in 4Q15, consolidating the view of a loosening labor market. With the economy expected to register some recovery next year, the labor market would not see significant loosening ahead. However, the composition of job growth is still likely to be dominated by lower quality employment. Full Report
  • Banrep surprised the market by leaving its policy rate unchanged in the first monetary policy meeting of the year. Following the earlier than expected rate cut in December, the market was near unanimous in its expectation for a 25-bp rate cut. However, the board opted to leave the policy rate at 7.5%. The decision was once more by majority, with a swing from the 4-3 vote in favor of a rate cut last month, to a 4-3 split in favor of staying on hold. The board agrees that there is a need for monetary easing, as the real interest rate is above the historical average since 2005 and activity remains weak. However, there is disagreement on the timing and speed of rate cuts, as the majority appears concerned by inflation expectations. In fact, following the approval of the tax reform and the upside surprise in December inflation, the latest analyst survey showed the 2017 inflation expectation rose to 4.5% (from 4.2%). The board also noted the increased uncertainty on global financial conditions since the previous meeting, supporting a more cautious approach. Be that as it may, the negative output gap and the fading of supply-side inflationary shocks support our call for further easing ahead: we expect the policy rate to reach 5.5% by YE17. Yet, the timing of each rate cut will likely be data-dependent.
  • The central bank board is set for another change. January’s meeting was the last for board member Carlos Gustavo Cano (openly against rate cuts amid above-target inflation expectations). President Santos will replace Cano, who has completed the maximum 12-year stay, as well as one other member of his choice in the upcoming weeks. So, the composition of the board could turn more favorable to rate cuts. Full Report

Market Developments

  • GLOBAL MARKETS: Major equity indexes traded on the red, after U.S. 4Q16 GDP fell short of market expectations. Nonetheless final domestic demand was firm, with consumption maintaining a solid pace and business fixed investment rebounding. Importantly, there are signs that business investment is gradually strengthening. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Oil traded lower (Brent: -1.33% to USD 55.49/bbl), after Baker Hughes data showed U.S. oil rig count rose (+15 rigs) for second straight week, suggesting  a reaction of shale-oil supply. Nonetheless, the MXN rallied (1.46% to 20.91/USD), reverting Thursday’s losses. The BRL also strengthened (1.07% to 3.1409/USD), followed by the COP (0.26% to 2,932.50/USD). The CLP bucked the regional trend, depreciating 0.16% to 651.00/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads narrowed all across LatAm. Brazilian risk premium dropped 6bps to 247bps – near 4-month lows. Mexican spreads tightened 2bps (to 164bps), as did Colombia’s (151bps). Chile CDS stood afloat at 82bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian rates staged a rally, as the narrowing of external yields added to good inflation news (cut in gasoline and diesel prices, maintenance of the green mode in the electric tariff flag system). In DI futures, the jan-21 tightened 9bps to 10.87%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican yields narrowed strongly, paying back to the previous sessions’ losses. In TIIE swaps, yields tightened by double-digit figures past the 3-year: the 5-year dropped 15bps to 7.60%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: Chilean rates oscillated up in the belly and in the back end. In Camara swaps, the 5-year increased 2bps to 3.65%. Chile Rates Tracker Colombian yields were narrowing prior to Banrep’s meeting (see Macro Backdrop). After the board stood put, yields at the very front end (3- and 6-month tenors) staged a correction. The curve is poised to flatten further on Monday. Colombia Rates Tracker

Upcoming Events 

  • In Brazil, December’s industrial production (Wed.), will be on focus. We expect production to expand 3.2% m/m, consistent with the widespread growth observed in the main coincident indicators. The final industrial business confidence reading for January (FGV) will come out (Tue.), for which the preview pointed to a 3.7% m/m seasonally adjusted increase. The nationwide unemployment rate for December will come through as well (Tue.). We forecast the unemployment rate to reach 11.9%, which in seasonally-adjusted terms corresponds to an increase to 12.5%. Moreover, Fenabrave vehicle sales for January will be released (Wed.) - we estimate sales of 153k vehicles. On the external sector, we expect the trade balance (Wed.) to post a surplus of USD 2.0 billion in January. The consolidated primary budget balance for December will come through (Tue.). We expect a BRL 76.3 billion deficit, with the central government result (Mon.) posting a BRL 68.7 billion deficit. Finally, Congress will return to its activities on Wednesday, one day before the elections for new Lower House and Senate leaders (Thu.). The Lava Jato Operation’s new rapporteur to replace Minister Teori Zavascki may be chosen next week.
  • In Mexico, the first survey that Banxico publishes after the liberalization of gasoline prices will be of note. Banxico will publish January’s expectations survey (Wed.). We expect a significant increase of short-term inflation expectations (especially for 2017), and a moderate increase for medium/long-term tenors. INEGI will announce the flash estimate of Q4’s GDP growth (Tue.). We forecast a growth rate of 2.3% y/y for 4Q16. The statistics institute will also announce November’s gross fixed investment. We expect it to print 0.3% y/y.
  • In Chile, high-frequency activity indicators are on the spotlight. The National Institute of Statistics will release activity indicators for December (Mon): we expect manufacturing production to decrease 1.5% y/y and retail sales to grow 5.8% y/y. Then, INE will publish the 4Q16 national unemployment rate (Tue.), which we anticipate at 6.2%. BCCh will publish the minutes from the January monetary policy meeting (Fri.). With the market now pricing in more rate cuts than the 50-bp cycle outlined in the 4Q16 Inflation Report, the minutes could provide some indication on the magnitude of the easing cycle.
  • In Colombia, the Inflation Report and export data are on the radar. DANE will publish export data for December (Thu.). We expect to see exports of USD 3.1 billion on the back of higher oil prices. Also important, Banrep will publish the 4Q16 Inflation Report (Fri.).

Latam Macro Calendar

Today's editor: Eduardo Marza


Macro Reports

BRAZIL - Tax collection: a bit better than expected, with some relief at the margin
 
Tax collection came at BRL 127.6 billion in December, a bit better than market expectation and our call (both at BRL 125 bn). This implies a small decline in real terms (-1.2% y/y vs 0.1% in November and -7.2% in October). In the 4Q, tax collection had a significant improvement (-1.6% y/y) over the 3Q (-6.4% y/y).
Tax collection 3-years decline tendency in real terms is showing some relief at the margin. In 2016, tax collection declined at a faster pace (-5.9% excluding repatriation bill revenues) and for the 3rd year in a row. However, recent signs point  to an improvement at the margin. We believe tax collection will have a very gradual recovery in 2017 as the economic activity indicators that matter the most for tax collection (real wage bill and retail sales) will continue to underperform GDP. This implies that the government will need around BRL 60 billion in non -recurrent revenues to comply with 2017’s primary result target (BRL 143 billion deficit or -2.2% of GDP) as we expect. The central government primary result from December will come next week.

Pedro Schneider



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