Itaú BBA - Brazilian yields tighten amid another round of downward IPCA revisions

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Brazilian yields tighten amid another round of downward IPCA revisions

June 26, 2017

Yields tightened 3-4bps pat the Jan-18, owing to downward revisions to inflation expectations.

With information available until 6:30pm Brasilia time

Highlights

  • Brazilian yields tightened 3-4bps past the Jan-18, as the market revised 2017 inflation expectations to the downside for the seventh week in a row (see Macro backdrop). In DI futures, the Jan-19 fell 4bps to 8.96% and the Jan-21 narrowed 3bps to 10.18%. The front end implies 175bps in rate cuts for the remainder of 2017. The belly of the Mexican curve narrowed for the third session in a row, helped by the upbeat MXN performance. In TIIE swaps, the 5-year tightened 4bps to 6.63%. The curve implies rate cuts of roughly 100bps until the end of 2018.
  • In currencies, the MXN strengthened 0.68% to 17.89/USD, the strongest level in 13 months. The BRL partly erased last week’s sell-off (+1.25% to 3.3013/USD). Andean pairs saw little action amid regional holidays.

Macro Backdrop

BRAZIL
  • Once more, the market revised to the dowside inflation expectations for 2017 and 2018. IPCA expectations for 2017 dropped to 3.48% (-16 bps), and to 4.3 (-3 bps) by YE18. GDP growth expectations remained roughly stable for 2017, reaching 0.39% (from 0.40%), and fell to 2.10% (from 2.20%) for 2018. Year-end Selic expectations stood flat at 8.50% for 2017, 2018 and 2019.
  • According to FGV monthly confidence survey, consumer confidence fell 2.3% mom sa in June. The decline reflects the recent increase in political uncertainty and was led by expectations (-3.1%) than by the current situation component (-0.6%). The percentage of people reporting that jobs are hard to get rose to 92.3% from 91.9%, interrupting a sequence of five consecutive declines. The percentage remains at high levels and is consistent with high unemployment rate for a while. The component of expected inflation continues to decline, while intention to purchase durable goods remains stable, but well below 2014 levels.
  • BCB placed the full offering of 8,200 FX swaps. After closing, it announced another roll over auction of up to 8,200 (USD 410 million) contracts on June 27.
MEXICO
  • In April, the IGAE GDP proxy posted a year-over-year contraction for the first time in almost four years due to adverse calendar effects. The IGAE index contracted 0.7% year-over-year, in line with our forecast and slightly stronger than the median market expectation (-1%), pulling down the 3-month moving average growth rate to 1.5% year-over-year (from 2.7% in March). However, calendar-adjusted growth in April was higher (2.7%), which means the statistics institute (INEGI) estimates a sizable calendar effect of -3.4 p.p. At the margin the index advanced at a modest 0.1% from the previous month, with quarter-over-quarter annualized growth falling to only 0.1% (from 1.7% qoq/saar in March). Services sectors gained 0.5% from the previous month, although their momentum has slowed down for five consecutive months (2% qoq/saar, from 2.2% in March). Industrial production, in contrast, fell 0.3% month-over-month, contracting by 1.1% qoq/saar (-0.4% previously).
  • In all, April’s data is consistent with our view that Mexico’s economy is slowing down, after surprising to the upside in 1Q17. The inflation spike, the uncertainty surrounding bilateral relations with the U.S., the tightening of macroeconomic policies (fiscal cuts and rate hikes) and the consistent fall of oil output represent the main headwinds. Exports will continue to act as a buffer, preventing a sharp weakening of the economy. In this context, we expect a 2.0% expansion this year (2016: 2.3%). Full Report
  • Labor market conditions remain tight. Unemployment rate posted 3.6% in May, slightly below our forecast (3.7%) and in line with median market expectations. The unemployment rate stands 0.4 p.p. below the level recorded in the same month of last year. Moreover, the seasonally-adjusted unemployment rate decreased to 3.5% (from 3.6% in April), back to the level observed in February (10-year low) after increasing slightly during March and April. Notably, formal employment (as per the data reported by the Mexican Institute of Social Security, IMSS) has been consistently growing at a solid pace (above 4% year-over-year) throughout the first five months of 2017. Looking ahead, however, we expect the slowdown of gross fixed investment (hurt by tighter macro policies and the uncertainty on Nafta renegotiation), to have a negative impact over formal employment growth, and hence deteriorate labor market conditions.
Market Developments
  • GLOBAL MARKETS: US Treasuries edged down 1-2bps after disappointing US activity data (durable goods orders, capital goods shipments). The 10-year inched down 1bp to 2.13%. Fed funds futures price-in 16% probability of Fed hike in September. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Oil registered gains for the third straight day (Brent: +0.79% to USD 45.90/bbl). Commodity-linked currencies gained 0.83% in average terms, surpassing the broad EMFX index (0.38%). By the time of writing, the MXN strengthened 0.68% to 17.89/USD, the strongest level in 13 months. The BRL partly erased last week’s sell-off (+1.25% to 3.3013/USD). Andean pairs saw little action amid regional holidays. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads (5-year) narrowed all across LatAm. Risk premium inched down 1bp in Chile (65bps) and Mexico (110bps). Colombia and Brazil decreased 3bps each to 131bps and 238bps, respectively. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Yields tightened 3-4bps pat the Jan-18, amid another round of downward IPCA revisions (see Macro backdrop) and the solid BRL performance. In DI futures, the Jan-19 fell 4bps to 8.96% and the Jan-21 narrowed 3bps to 10.18%. The front end implies 175bps in rate cuts for the remainder of 2017. Brazil Rates Tracker
  • LOCAL RATES - Mexico: The belly of the curve narrowed for the third session in a row, helped by the upbeat MXN performance. In TIIE swaps, the 5-year tightened 4bps to 6.63%. The curve implies rate cuts of roughly 100bps until the end of 2018.Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: Chilean and Colombian markets were closed due to a holiday.

Upcoming Events

  • In Brazil, the week’s highlight will be the National Monetary Council meeting (Thu.). The CMN will decide on the 2019 inflation target and the TJLP long term interest rate. In our view, a lower inflation target for 2019 would reinforce the outlook for lower inflation and anchored expectations. Local news have been indicating a reduction in the 2019 inflation target to 4.25% or 4.0% (from 4.5%). In addition, we expect no change to the TJLP in the near future, currently at 7.0%. Moreover, the nationwide unemployment rate for May will come out (Fri.), and we expect a 0.2% increase to 13.4% (our seasonal adjustment). On fiscal accounts, the consolidated primary budget balance for May will come through (Fri.). We expect a BRL 21.5 billion deficit. Onto the balance of payments report (Tue.), we expect a USD 1.9 billion current account surplus in May. We expect direct investment in the country (DIC) to register inflows of USD 3.0 billion in May - if confirmed, DIC will amount to USD 82 billion over 12 months. Also noteworthy, FGV’s monthly surveys for June on commerce, construction, industry and services will be released through the week.
  • In Mexico, external and fiscal releases are on the radar. May’s trade balance (Tue.) will come through. Also, the Ministry of Finance will announce May’s fiscal balance (Fri.). We expect the fiscal deficit indicators to continue narrowing, as fiscal consolidation makes headway.
  • Activity data is on the spotlight in Chile. The national statistics agency (INE) will publish the industrial activity indicators for the month of May (Fri.). We expect manufacturing production to decline 0.3% from last year (-7.5% in April). INE will also publish the national unemployment rate for the quarter ending in May (Fri.). We expect the unemployment rate to reach 6.9% (6.8% one year ago).
  • In Colombia, we expect Banrep to deliver another 25-bp rate cut (taking the policy rate to 6.0%) in its monthly monetary policy meeting (Fri.). The unemployment rate for the month of May will be also released (Fri.). We expect the labor market to remain weak ahead amid low dynamism of the Colombian economy and see the urban unemployment rate to rising to 10.7% in May.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza



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