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Brazilian yields rally after another downside CPI surprise

March 10, 2017

The Brazilian curve bull-flattened as February’s inflation came in below the bottom of market estimates.

With information available until 6:30pm Brasilia time

Highlights

  • The Brazilian curve bull-flattened substantially as February’s inflation came in below the bottom of market estimates (see Macro Backdrop). In DI Futures, the Jan-18 went down 18bps to 10.07% and the Jan-21 decreased 23bps to 9.97%. The cuts implied in the front end increased to 101bps for the April Copom meeting and to 81bps for the June meeting. For the full year, the curve sees 289-332bps in rate cuts, pending on the term premium estimate. Accordingly, breakevens tightened by double digit figures across the curve; the 5-year fell 19bps to 4.52%.
  • In Colombia, IBR swaps tightened after Banrep’s minutes revealed the majority of the board is more concerned on activity (see Macro Backdrop). The 1-year fell 5bps to 6.10% and the 5-year decreased 6bps to 5.86%. The curve now sees 111bps in rate cuts by YE17, from 100bps as of Thursday.
  • In LatAm FX, all the currencies under our coverage appreciated on a post-Payroll correction. The CLP gained 0.16% to 664.00/USD and the MXN strengthened 1.01% to 19.64/USD. The BRL ranked the top performer across the majors (1.63% to 3.1419/USD) and the COP closed at 2,983.50/USD (0.49%), boosted by Fitch’s outlook revision (see Macro Backdrop).

Macro Backdrop

BRAZIL
  • IPCA increased 0.33% m/m in February, below the bottom of market estimates. The index came in below our estimate (0.45%) and market consensus (0.43%). Deviations were spread across market-set prices, with lower results for food consumed at home, services, and industrial prices. According to census bureau IBGE, it was the lowest reading for February since 2000. The index had risen 0.38% in January and 0.90% in February 2016. The change in headline inflation slowed down to 4.76% y/y from 5.35% y/y in January. The largest upward contribution during the month came from education (0.23 p.p.), driven by tuition adjustments, particularly for regular courses (0.21 p.p.). We also highlight contributions from healthcare and personal care (0.08 p.p.), transportation (0.04 p.p.), and housing (0.04 p.p.). On the other hand, food and beverage prices dropped 0.45% and caused an impact of -0.11 p.p. on monthly inflation. Our preliminary estimate for the IPCA in March stands at 0.27% m/m, prompting another decline in the annual change to 4.6%. Full Report
  • According to ABCR, traffic of heavy vehicles increased 2.0% m/m in February. Along with other coincident indicators, we changed our forecast for industrial production in February to 0.5% m/m (from 0.3%).
  • We publish our scenario review for the month of March. Economic activity has been showing signs of a gradual recovery, likely having started in 1Q17. We forecast 1.0% GDP growth in 2017 and 4.0% growth in 2018. Inflation and inflation expectations continue to fall. We have reduced our 2017 forecast for the extended national consumer price index (IPCA) to 4.1% (from 4.4%). We maintain our 3.8% inflation forecast for 2018.The Central Bank of Brazil (BCB) has signaled the possibility of further interest rate cuts and frontloading the easing cycle. We now expect a year-end Selic rate of 8.25% for both 2017 and 2018. Full Report

COLOMBIA

  • The minutes from the central bank’s February monetary policy meeting show increasing concern over activity. The entire board agreed that conditions exist to gradually lower the interest rate. However, there remain differences within the board on the timing of rate cuts. In justifying its decision to cut the policy rate by 25bps to 7.25%, this camp highlighted the low growth outlook for this year, the weak performance of industrial production in recent months as well as the gradual increase in the urban unemployment rate. Since the February meeting, inflation surprised to the downside, raising the likelihood that the central bank opts for a consecutive rate cut this month. Looking ahead, we expect the board to continue to cut rates - though not consecutively - as internal demand remains fragile, while the effects from previous supply shocks on inflation diminish. We see the policy rate at 5.5% by the end of the year. Full Report
  • Fitch affirmed Colombia’s sovereign credit rating at “BBB”, but revised the negative outlook to stable. The decision reflects a number of positive developments in Colombia. Firstly, the ratings agency sees that there has been a reduction in macroeconomic imbalances – a significant reduction in the current account deficit, diminished uncertainties surrounding Colombia's fiscal consolidation path due to the passing of tax reform measures late last year, and the expectation that disinflation towards the central bank's target would continue. Additionally, Fitch highlighted “the disciplined policy response to increased pressures following the slump in commodity prices should help in keeping macroeconomic imbalances in check during the forecast period” as a positive factor. The agency expects the government to meet its 3.3% of GDP target in 2017 due to the tax measures passed in 2016 and highlighted the adequate FX reserve levels, the conclusion of the peace deal with the FARC and the country’s track record as an inflation targeting-economy. S&P holds a 'BBB' rating for Colombia with a negative outlook; meanwhile, Moody’s has Colombia’s sovereign rating at 'Baa2' with a stable outlook. We note structural challenges remain, making the need for further fiscal consolidation or another tax reform a must, especially after 2019. Full Report Below

Market Developments 

  • GLOBAL MARKETS: Treasuries tightened on a post-payroll correction. For the 5-year and 10-year, rates fell 3bps to 2.10% and 2.58%, respectively. The US labor report showed job creation consolidated above 200k, a decline in the unemployment rate (even with rising labor participation) and wage inflation rebounds to its upward trend. The strong report increased the chance of 4 hikes by the Fed in 2017. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Oil prices extended losses, as, according to Baker Hughes data, US oil rigs went up for the eight consecutive week. WTI fell 1.66% to USD 48.46/bbl. In LatAm FX, all the currencies under our coverage appreciated due to the post-Payroll correction. The CLP gained 0.16% to 664.00/USD and the MXN strengthened 1.01% to 19.64/USD. The BRL ranked the top performer across the majors (1.63% to 3.1419/USD) and the COP closed at 2,983.50/USD (0.49%), boosted by Fitch’s outlook revision (see Macro Backdrop). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: All across LatAm credit spreads for the 5-year tenor decreased. Chilean and Mexican spreads inched down 1bp to 75bps and 138bps, respectively. Brazil CDS fell the most in the region, to 232bps (-4bps), reverting Thursday’s movement. Colombian country risk decreased 3bps to 137bps, consistent with Fitch’s outlook upgrade. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bull-flattened substantially as February’s inflation came in below the bottom of market estimates (see Macro Backdrop). In DI Futures, the Jan-18 went down 18bps to 10.07% and the Jan-21 decreased 23bps to 9.97%. The cuts implied in the front end increased to 101bps for the April Copom meeting and to 81bps for the June meeting. For the full year, the curve sees 289-332bps in rate cuts, pending on the term premium estimate. Accordingly, breakevens tightened by double digit figures across the curve; the 5-year fell 19bps to 4.52%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican rates traded lower in the session. In TIIE swaps, the 1-year decreased 2bps to 7.21% and the 5-year fell 4bps to 7.44%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, short rates (until 3-year) fell and longer-dated ones traded range bound. In Camara swaps, the 1-year fell 4bps 2.92% and the 10-year inched up 1bp to 4.27%. Chile Rates Tracker In Colombia, IBR swaps tightened after Banrep’s minutes revealed the majority of the board is more concerned on activity (see Macro Backdrop). The 1-year fell 5bps to 6.10% and the 5-year decreased 6bps to 5.86%. The curve now sees 111bps in rate cuts by YE17, from 100bps as of Thursday. Colombia Rates Tracker

Upcoming Events

  • In Brazil, February’s Industry employment data for the state of Sao Paulo (FIESP) will be in focus (Thu.). In recent months, employment has shown more modest marginal declines. Then, industrial business confidence (CNI) for March will be released (Fri.). In the previous month, confidence increased 6.7%, representing a second relevant gain at the margin. We expect the current upward trend in industrial confidence to continue ahead.
  • In Mexico, the National Association of Department Stores and Supermarkets (ANTAD) will announce February’s same-store-sales (Mon.). We expect ANTAD sales to slow down significantly, to 3% y/y (from an average of 6.3% in 4Q16). Moreover, the statistics institute (INEGI) will publish January’sindustrial production (Tue.). We expect a 0.4% y/y expansion, up from a 0.6% contraction recorded in December, driven by a pick-up of manufacturing exports (which accelerated in January).
  • In Chile, the central bank of Chile will hold the March monetary policy meeting (Thu.). We expect the board to cut the policy rate by 25bps to 3.0% and to retain the easing bias.
  • In Colombia, the National Institute of Statistics (DANE) will release January’s activity data (Tue.). We expect industrial production to expand 2.3% y/y (previous: 2.2%), aided by a favorable calendar effect. Meanwhile, retail sales are likely to grow 3.0% in twelve months (previous: 6.2%), as car sales slowed down. Moving forward, think-tank Fedesarrollo will release the February consumer confidence (Wed.). In the previous month, consumer confidence reached a historic low following the approval to increase the sales tax rate. Then, the trade balance for the month of January will be published (Fri.). We expect a trade deficit of USD 815 million, smaller than the USD 1.5 billion deficit recorded one year ago. Moreover, the central bank may publish the current account balance for 4Q16. We expect a USD 2.2 billion deficit (4Q15: USD 4.1 billion deficit).

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa


Macro Report

COLOMBIA - Fitch revises negative outlook to stable

Fitch affirmed Colombia’s sovereign credit rating at 'BBB', but revised the negative outlook to stable. The announcement effectively reverts the decision adopted last July, when the agency revised the outlook on Colombia's rating to negative from stable, while leaving the rating unchanged. Last year’s revision considered Colombia’s vulnerabilities elevated given the country’s current account deficit was well above the ‘BBB’ median (1.6%), while government debt lifted to levels above its rating peers.

Today’s decision to upgrade the outlook to stable reflects a number of positive developments in Colombia. Firstly, the ratings agency sees that there has been a reduction in macroeconomic imbalances – a significant reduction in the current account deficit, diminished uncertainties surrounding Colombia's fiscal consolidation path due to the passing of tax reform measures late last year, and the expectation that disinflation towards the central bank's target would continue. Additionally, Fitch highlighted “the disciplined policy response to increased pressures following the slump in commodity prices should help in keeping macroeconomic imbalances in check during the forecast period” as a positive factor.

Fitch expects the government to meet its 3.3% of GDP target in 2017 due to the tax measures passed in 2016. Despite the positive impact of the tax reform, Fitch sees the need for expenditure containment in order to meet Colombia’s fiscal deficit target over the medium term. In spite of gross general government debt reaching close to 50% in 2016 -- nearly 10 pp above the ‘BBB’ median --, Fitch expects debt to stabilize over the forecast period given the gradual pace of fiscal consolidation and a “modest appreciation” of the currency.

Fitch also highlighted adequate FX reserve levels, the conclusion of the peace deal with the FARC and the country’s track record as an inflation targeting-economy. Meanwhile, low growth represents a challenge for fiscal consolidation. Fitch expects growth to modestly pick-up to 2.3% this year on the back of higher exports and investment -- supported by the 4G infrastructure program -- as well as monetary easing, despite the drag from fiscal consolidation.

The move comes as a surprise given Fitch’s recent statements on Colombia’s sovereign outlook. A recent report said “the medium-term effects of some of the measures in the package, such as tax evasion prohibitions and measures to increase labor market formalization are more difficult to quantify.” The report added that “successful implementation of tax reform, continued expenditure restraint and prioritization will be required to meet medium-term fiscal targets”. Fitch estimates Colombia’s current account deficit was below 5% of GDP in 2016, down from 6.5% in 2015. “Further adjustment in the current account balance is needed to stabilize the rise in external debt”.

S&P holds a 'BBB' rating for Colombia with a negative outlook, meanwhile, Moody’s has Colombia’s sovereign rating at 'Baa2' with a stable outlook. We note structural challenges remain, making the need for further fiscal consolidation or another tax reform a must, especially after 2019.

Vittorio Peretti

 



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