Itaú BBA - Brazilian yields narrow as IPCA prints below expectations

Latam FI Strategy Daily

< Back

Brazilian yields narrow as IPCA prints below expectations

June 9, 2017

DI futures narrowed substantially as May annual inflation fell to 10-year lows.

With information available until 6:30pm Brasilia time


  • DI futures narrowed substantially as May annual inflation fell to 10-year lows (see Macro Backdrop). In DI futures, the Jan-18 fell 15bps to 9.17% and the Jan-19 went down 20bps to 9.21%. For the next Copom meeting (July 25-26), the curve now implies 76bps in cuts from 68bps as of Thursday. 
  • In FX, most currencies under our coverage appreciated. Once again, the CLP (+0.39% to 663.49/USD) strengthened on the back of higher copper prices (+1.40%). Moreover, the MXN is trading 0.14% stronger to 18.17/USD and the COP is broadly flat at 2,917.29/USD (+0.07%). Bucking the regional trend, the BRL depreciated 1.07% to 3.2968/USD. 

Macro Backdrop

  • IPCA prints below expectations in May and the year-over-year change recedes to 3.6%. The index increased 0.31% in May, below our call (0.48%) and the median of market expectations (0.47%). The deviation from our forecast was spread across market-set prices. The index had risen 0.14% in April and 0.78% in May 2016. Year-to-date, the IPCA climbed 1.42%, down significantly from 4.05% in the year-earlier period. The year-over-year change in headline inflation slid to 3.60% (the lowest reading since May 2007, according to census bureau IBGE) from 4.08% in April. Breaking down by product groups, the largest upward contribution during the month came from housing (0.32 p.p.), followed by healthcare and personal care (0.07 p.p.), and apparel (0.06 p.p.). In the housing group, electricity bills climbed 9% and caused an impact of 0.29 p.p. on headline inflation, due to the reversal of the compensation in April for an undue charge related to Angra III. On the other hand, food and beverages (-0.09 p.p.), transportation (-0.07 p.p.), and household items (-0.01 p.p.) posted negative changes. 
  • Our preliminary estimate for the IPCA in June is a slightly negative change (-0.05%), pushing the year-over-year change down further to 3.2%. Electricity will give the biggest negative contribution, falling about 6% and providing 0.20 p.p. relief to monthly inflation. Electricity bills decline as the green mode was triggered under the tariff flag system (after two consecutive months in red mode), thanks to improved hydrologic conditions and corollary reduction in power generation costs. Full Report
  • Traffic of heavy vehicles rose 4.1% mom/sa in May (our seasonal adjustment). The index is up 4% yoy, following a negative figure in April (due to fewer working days). Overall, coincident indicators already released for May show growth in economic activity, after two weak months. The strong result, together with other coincident indicators, is consistent with a monthly increase in industrial production in May. Our preliminary forecast for industrial production now stands at +0.6% mom/sa and +3.2% yoy (from: +0.1 mom/sa, 2.4% yoy). 
  • By the time we wrote this piece, five Electoral Court (TSE) ministers had voted in the Dilma-Temer ticket trial. According to the Globo, Herman Benjamin and Luiz Fux voted in favor of annulling the 2014 presidential election result. In contrast, ministers Napoleão Maia, Admar Gonzaga and Tarcisio Vieira voted against. 
  • The BCB placed the full offering of 8,200 FX swaps. After closing, the central bank called for a roll over auction of up to 8,200 contracts on June 12. 
  • Weak Industrial Production in April, in spite of a solid Manufacturing sector. Industrial production contracted by 4.4% year over year in April, surprising market expectations (-2.1%) and our own forecast (-2.8%) to the downside. Adjusting for calendar effects, industrial production fell by 0.4%, following a 0.2% drop in March, with mining output down by 9.6% (-10% in March), construction falling 2.7% (+0.4% previously) and Manufacturing recovering to 5.0% (2.9% before). At the margin, industrial production fell for a third consecutive month (-0.3% in April), bringing its quarter-over-quarter growth rate to -1.1% (annualized). Mining output was down by 6.6% qoq/saar, while construction contracted 4.9%. On the other hand, manufacturing production grew 2.4%, although this represents a slowdown from the 4.8% rate posted in 1Q17. The numbers are consistent with our qualitative view that industrial production will remain weak throughout this year, as fiscal consolidation and uncertainties over trade relations with the U.S. hit construction investment and oil production (due to lower investments by Pemex), while growth in the U.S., amid a more competitive exchange-rate, benefit the manufacturing sector. Full Report
  • Compared to May last year, consumer confidence in Chile is improving. Nevertheless, confidence remains in pessimistic territory (below 50), completing three years beneath the neutral level. According to Adimark, consumer confidence in May came in at 40.3 points, from 33.9 points in the 2016 corresponding period (40.1 in April 2017), with all sub-indices posting an improvement over the twelve month period. Compared to May 2016, the evaluation of the current state of the economy and personal wellbeing improved by around 8 points, with household goods consumption returning to optimistic territory (at 52.7) after three months below neutral. The short-term (12-monts ahead) expectation indicator increased 9.6 points, likely reflecting optimism as the presidential election approaches. However, the long-term economic outlook remains low at 26.9 points (0.8 point up from May 2016), as consumers are likely concerned over whether the economic slowdown is more structural rather than cyclical in nature. Low inflation and interest rates will likely aid an improvement in confidence going forward, alongside less uncertainty as the election nears. Nevertheless, the loosening of the labor will likely limit the improvement to sentiment. We expect economic growth of 1.6% this year, stable from 2016.
  • The minutes from the central bank’s May monetary policy meeting confirm unease over the future evolution of inflation favored a reversion to a 25-bp rate cut pace. The document indicates that the decision to lower the policy rate by 25bps to 6.25% by a 4-3 majority (after a 50bp cut was implemented in April) was triggered by sticky core inflation and an uptick in inflation expectations. Overall, the majority of the board seems comfortable that the current pace of rate cuts will have the desired effect on aiding activity. Activity in the first quarter of the year disappointed, coming in below the central bank’s expectations (1.1% vs. 1.3%). Nevertheless, the central bank retained its growth estimate for this year at 1.8% (2% last year). 
  • We continue to see rate cuts ahead. Our baseline scenario has the policy rate at 5.5% by yearend (from the current 6.25%) with future rate cuts being data dependent. In particular, inflation data for this month (headline inflation decelerating towards the 4% upper bound of inflation, but sticky non-tradable inflation) would justify another 25-bp cut at this month’s meeting. Yet, upcoming activity data could lead to a more aggressive move. Full Report
Market Developments 
  • GLOBAL MARKETS: The GBP depreciated 1.65% on Friday after the UK election. Conservatives actually lost 12 seats to 318 whereas Labour gained 29 seats to 261. We think the hung parliament outcome will maintain Brexit negotiations uncertainty. Markets will focus from now on the National Assembly elections. Macron is expected to win an absolute majority, and hence the French Parliament would likely start debating the labor reform by this summer. For global markets, the confirmation of a strong Macron majority and the strengthening of the Franco-German pro-EU alliance are more relevant than the UK election’s result. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities traded higher (CRB futues: +0.38%) in the session. Copper (+1.40%) and oil increased (WTI: +0.61% to 45.92/bbl). In FX, most currencies under our coverage appreciated. Once again, the CLP (+0.39% to 663.49/USD) strengthened on the back of higher copper prices. Moreover, the MXN is trading 0.14% stronger to 18.17/USD and the COP is broadly flat at 2,917.29/USD (+0.07%). Bucking the regional trend, the BRL depreciated 1.07% to 3.2968/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm Credit spreads for the 5-year tenor were broadly stable. Brazilian, Chilean and Colombian spreads stood flat at 237bps, 69bps and 127bps, respectively. In Mexico, however, country risk narrowed 2bps to 109bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian yields narrowed substantially as IPCA in May came in below expectations (see Macro Backdrop). In DI futures, the Jan-18 fell 15bps to 9.17% and the Jan-19 went down 20bps to 9.21%. For the next Copom meeting (July 25-26), the curve now implies 76bps in cuts from 68bps as of Thursday. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican rates were mixed in the session. In TIEE swaps, while short rates fell (1-year: -1bp to 7.43%), long ones stood broadly flat (5-year: at 7.15%). Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, long rates widened tracking US treasuries. In Camara swaps, short yields (up to 18-month) stood flat whereas past 2-year, they increased 2bps (5-year: +2bps to 3.43%). Chile Rates Tracker In Colombia, most rates narrowed in the session. In IBR swaps, the 1-year inched down 1bp to 5.13% and the 5-year went down 2bps to 5.20%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, the key releases for the week will be April’s retail sales numbers (Tue.) and the Service Sector Survey (PMS) (Wed.). We forecast a 1.6% decline in core retail (month-over-month, seasonally adjusted), and a 0.2% drop in the broad segment, which includes vehicle sales and construction material. April’s PMS may have a relevant impact on GDP estimates for 2Q17 - we expect the headline to fall 5.8% year-over-year. Furthermore, the BCB will release during the week its monthly activity index (IBC-Br) for April. Then, the reading of the labor reform report in the Senate’s Social Affairs Committee may occur during the week. The proposal has already been approved by the Senate’s Economic Affairs Committee. 
  • In Mexico, the National Association of Department Stores and Supermarkets (ANTAD) will announce May’s same-store-sales (Mon.). We expect it to slow down to 3.5% year-over-year (from 6% in April). 
  • In Chile, the central bank will hold its June monetary policy meeting (Thu.). The central bank has implemented four 25-bp rate cuts in the first five months of the year, taking the policy rate to 2.5%. We expect BCCh to stay on hold this month. The minutes from the previous meeting alongside the 2Q inflation report released after the May meeting reveal a board that appears content to wait and observe how the economy unfolds given the monetary stimulus already implemented. 
  • In Colombia, activity indicators for the month of April will be published (Thu.). We expect industrial production to decrease 5.0% year over year (+4.8% in March). Meanwhile, retail sales likely saw a 0% growth rate (+1.9% previously). Then, think-tank Fedesarrollo will release the May consumer confidence (Thu.). Falling inflation, lower interest rates, and a firmer currency will likely aid some confidence recovery ahead. During the week, the central bank is expected to publish the current account balance for 1Q17. We expect a USD 2.4 billion deficit, smaller than the USD 3.6 billion deficit in 1Q16, as the trade balance of goods improved from one year ago on the back of recovering commodity prices and a weakening domestic demand.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

< Back