Itaú BBA - Brazilian yields narrow on positive pension reform headlines and sustained disinflation

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Brazilian yields narrow on positive pension reform headlines and sustained disinflation

May 10, 2017

DI futures narrowed as articles suggest the government is reaching the necessary votes for the approval of the pension reform in the Lower House floor.

With information available until 6:30pm Brasilia time

Highlights

  • In rates, DI futures narrowed as articles suggest the government is reaching the necessary votes for the approval of the pension reform in the Lower House floor. In DI futures, the Jan-18 fell 7bps to 9.28% and the Jan-21 went down 6bps to 9.81%. Real rates also fell as the May-19 decreased 8bps to 4.73%.
  • Commodities traded higher in the session on the back of oil and iron ore prices. In LartAm FX, currencies under our coverage appreciated as commodity-linked (+1.10%) currencies posted gains. The COP posted gains of 0.87% to 2,944.10/USD and the CLP went to 672.12/USD (0.86%). The MXN is trading 0.83% higher to 19.00/USD. At last, the BRL strengthened 0.69% to 3.1674/USD after the final step to the Social Security reform in the Lower House Special Committee was concluded Tuesday night.

Macro Backdrop

BRAZIL
  • IPCA rose 0.14% in April; year-over-year change slides to 4.1%. The data came in line with our call and the median of market expectations (both at 0.15%). The index had risen 0.25% in March and 0.61% in April 2016. Year-to-date, the IPCA climbed 1.10%, down significantly from 3.25% in the year-earlier period. The year-over-year change in headline inflation slid to 4.08% (the lowest reading since July 2007, according to census bureau IBGE) from 4.57% in March. Breaking down by product groups, the largest upward contributions during the month came from food and beverages (0.15 p.p.), and healthcare and personal care (0.12 p.p.). On the other hand, the housing group provided the largest downward contribution (-0.17 p.p.), following the reduction in electricity bills. The 6.4% decline in electricity bills during the month (impact of -0.22 p.p.) comes after an undue charge tied to the Angra III power plant, which more than offset the impact of the red mode triggered in the tariff flag system early in the month. 
  • Our preliminary estimate for the IPCA in May stands at 0.50%, prompting another decline in the year-over-year change to 3.8%. The housing group will account for nearly 75% of the increase, as electricity bills will rise due to the reversal of the Angra III effect, which had prompted a temporary drop in the item in the previous month. Full Report
  • Traffic of heavy vehicles fell 0.4% mom/sa in April (our seasonal adjustment). The index is down 8.3% yoy due to fewer working days compared to 2016. The release closes the cycle of industrial production coincident indicators for April. The result is consistent with yet another monthly decline in industrial production in April. Our preliminary forecast for industrial production is -0.1% mom/sa and -5.9% yoy, slightly up from Tuesday’s estimate (-0.3% mom/sa, -6.2% yoy). 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 seasonal adjustment fails to fully account fewer working days in April 2017 than the historical average for the month. Nonetheless, economic activity figures are showing renewed weakness on March/April after a short improvement between December and February.
  • The final step to the Social Security reform in the Lower House Special Committee was concluded Tuesday night. Nine out of ten amendments were rejected by the majority; however, the single approved amendment does not yield significant changes. The next step is the first round vote in the Lower House floor, where the government will need 308 votes out of 513 in favor for the reform’s approval.
MEXICO
  • Supermarket & department store (ANTAD) same-store sales surprised to the upside in April, indicating that private consumption remains resilient to the headwinds. ANTAD sales grew 6% y/y in April – above market expectations (3.2%) and our own forecast (2.5%) – with the 3-month moving average growth rate picking up to 4.2% y/y (up from 3.6% in March). The acceleration came in spite of a one-off negative effect (shift in Mother’s Day promotions to May, unlike in 2016 when they took place in April). In fact, the abovementioned negative one-off effect had a significant impact in department store sales (which fell 5% y/y), although this was offset by the strong performance of supermarkets (9.4% y/y) and specialized stores (7.9% y/y). The Easter holidays, curiously, are considered to have a positive effect on ANTAD sales, so the negative-calendar effect (from less business days) is probably negligible.
  • Although we expect weaker private consumption in coming quarters, due to weaker fundamentals, the risks are for a more moderate slowdown than we were previously expecting. The performance of service sectors in 1Q17 (4.1% qoq/saar, according to the flash estimate of GDP) and the monthly private consumption indicator (6.4% qoq/saar in February) were already indicating that consumption remained strong, at least until 1Q17. Fundamentals, however, are deteriorating further. Inflation jumped to 5.8% y/y in April (from 5.4% y/y in March), which will make real wages to fall at a sharper pace (from -0.7% y/y in 1Q17). The strength of formal employment has not been enough to offset the increase of inflation, so the real wage bill has been slowing down. Moreover, the labor market has to give in at some point. We believe employment creation will eventually deteriorate as investment slows down (dragged by tighter macro policies and the uncertainty surrounding bilateral relations with the US).
CHILE
  • Consumer confidence in April continued to edge up from one year ago and previous months. Nevertheless, confidence levels remain well entrenched in pessimistic territory (< 50), but still remains at low levels. According to Adimark, consumer confidence in the came in at 40.1 points, from 34.6 points in the 2016 corresponding period (37.3 in March 2017), with all sub-indices moving towards neutral territory (50), but failing to reach this level. Despite the improvement, total confidence has now completed three full years in pessimistic territory. Compared to April 2016, both short-term (12-monts ahead) and long-term (5-year ahead) expectation indicators increased by around 5 points. Short-term economic views regarding the expectation for current purchases of household goods is the closest to holding a neutral view at 48.6 points (43.7 one year ago and 47.2 in March). As presidential election approaches (November), the longer-term outlook is also on the mend. Compared to the previous month, the 5-year economic outlook rose from 24.6 points to 32.7 points. Going forward, business and consumer confidence will likely show improvement as uncertainty over the electoral outcome decreases. Low inflation and interest rates will also aid an improvement. Nevertheless, the loosening of the labor will likely limit the improvement to confidence. Low private sentiment has played a key part behind the extended economic slowdown in Chile. We expect GDP growth of 1.8% this year, broadly stable from the 1.6% recorded for 2016.
  • The central bank’s economic analyst and trader surveys show that the market expects the central bank to pause at its May 18 monetary policy meeting. The central bank has implemented three 25bp rate cut so far this year. The central bank initiated an easing cycle in January, strategically pausing in February, and resuming the cycle in March and April. The central bank retained an easing bias alongside the rate cut at last month’s meeting, hinting at room for additional easing. In the minutes of the April meeting, the technical staff argued that the Inflation Report’s guidance (of a cycle of 75bps – already implemented) did not represent an unwavering commitment. The board agreed with this position by signaling further loosening ahead. Recently central bank vice-president Sebastian Claro joined President Marcel and board-member Joaquín Vial when he noted that he does not see the policy rate going beyond 2.5% unless there is a relevant deviation from the baseline scenario. According to the central bank’s surveys, 72% of analysts see a pause this month, with a final rate cut to 2.5% in June. Meanwhile, 57% of traders also expect rates on hold, but do see one final cut in the next three months. The policy rate is expected to stay at 2.5% for at least a year. We believe that sticky core service inflation and a favorable activity surprise gives leeway for a pause at this month’s meeting. Overall, we believe the central bank has a clear, but limited, appetite for additional easing. We expect the policy rate to reach 2.5% in June and remain there well into 2H18.
Market Developments 
  • GLOBAL MARKETS: Despite political concerns in the US and geopolitical in the Pacific, the VIX is still hovering around 1993 lows. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities traded higher (CRB futures index: +1.25%) on the back of oil and iron ore (+1.28%). After the weekly DOE report, oil prices surged (WTI: +3.31% to USD 47.40/USD – largest daily gain since the Opec meeting). EIA’s report showed US crude oil inventories dropped 5.2 million barrels last week - the largest weekly decline this year, beating analysts’ forecast of a 1.7 million fall. On the other hand, soybean prices fell 0.39% after the USDA’s monthly report showed global final stocks for the 16/17 crop were revised upwards by 2.7 million tons. In LartAm FX, currencies under our coverage appreciated, since commodity-linked (+1.10%) currencies posted gains. The BRL strengthened 0.69% to 3.1674/USD after the final step to the Social Security reform in the Lower House Special Committee was concluded Tuesday night. The COP posted gains of 0.87% to 2,944.10/USD and the CLP went to 672.12/USD (0.86%). The MXN is trading 0.83% higher to 19.00/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads for the 5-year tenor narrowed all across LatAm. CDS in Chile went down 2bps to 73bps. Colombian spreads decreased 3bps to 130bps and Mexican fell 4bps to 116bps. Country risk in Brazil went down the most, to 208bps (-6bps) - lowest level since January 2015. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian yields narrowed as articles suggest the government is reaching the necessary votes for the approval of the pension reform in the Lower House floor. In DI futures, the Jan-18 fell 7bps to 9.28% and the Jan-21 went down 6bps to 9.81%. Real rates also fell as the May-19 decreased 8bps to 4.73%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Long Mexican rates narrowed 2bps in the session. In TIIE swaps, while the 1-year stood flat at 7.35%, the 5-year went down 2bps to 7.31%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, short yields narrowed 4bps. In Camara swaps, while short rates went down (1-year: -2bps to 2.56%, long traded range bound (10-year: +1bp to 4.15%. Chile Rates Tracker In Colombia, rates traded 1-3bps higher. In IBR Swaps, the 9-month went up 2bps to 5.38% and the 5-year increased 3bps to 5.40%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, 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. 
  • In Mexico, 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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