Itaú BBA - Brazilian yields tighten as the consensus sees a lower inflation target for 2019

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Brazilian yields tighten as the consensus sees a lower inflation target for 2019

March 27, 2017

The DI Futures curve bull steepened as long inflation expectations drop below 4.50%.

With information available until 6:30pm Brasilia time


  • The Brazilian curve bull steepened as long inflation expectations drop below 4.50% (see Macro Backdrop). Also, market talks of a revision of the 2017 fiscal target were dismissed by the Ministry of Planning in an emailed statement. In DI Futures, the Jan-18 decreased 6bps to 9.84% and the Jan-21 went down 2bps to 9.85%.
  • Commodities traded lower as soybean prices decreased 0.44% and iron ore prices fell 4.40%. Hence, commodity-linked currencies posted losses (Commodity FX: -0.31%). In LatAm FX, all currencies under our coverage depreciated. The CLP decreased 0.62% to 664.63/USD and the COP traded 0.73% lower to 2,919.00/USD. The MXN posted losses of 0.71% to 18.76/USD and the BRL closed at 3.1266/USD (-0.59%).

Macro Backdrop

  • Tax collection in line with expectations. Tax collection came in at BRL 92.4 billion in February, in line with market expectation and our call (both at BRL 93.0 billion). This implies a positive result in real terms (0.4% y/y) for the second month in a row (January: 0.8% y/y; 4Q16: -2.1%). As the Federal Revenue Service reported, tax collection has been positively influenced by higher profits, tax rises on capital gains and higher royalties revenues, while taxes more linked to economic activity keep a slower recovery. 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. As so, to deal with a challenging primary result target of a BRL 143 billion deficit (-2.2% of GDP), the government may announce Tuesday a combination of around BRL 58 billion in non -recurrent revenues, tax hikes and discretionary expenditure cuts. The central government primary result from February will hit the wires on Thursday. We revised our forecast to a BRL 20.6 billion deficit (from: BRL 20.2 billion).
  • Consumer confidence further increases. Consumer confidence (FGV) increased 4.3% m/m in March, influenced more by rises in the expectations component (+5.6%) than in the current situation component (+1.7%). Vis-à-vis December 2016 low readings, the index has grown 16.7% - reaching its highest level since December 2014.  The intention to purchase durable goods was up 3.2% in the month – highest level since March 2015. The percentage of people reporting that jobs are hard to get fell for the third consecutive month (to 94.8% from 95.9%), but still remaining at high levels. 
  • 2019 inflation expectations dip below BCB’s target. According to BCB’s Focus survey, median inflation expectations for 2017 declined to 4.12% (-3bps), and 2019 expectations fell to 4.35% (-15bps). Year-end Selic expectations did not change. Also, the market sees a slightly more appreciated BRL, at 3.28/USD by YE17 (from: 3.29/USD), and at 3.49/USD by YE19 (from: 3.50/USD). GDP growth expectations inched down for 2017 to 0.47% (from: 0.48%), while in 2018 and 2019 stood flat at 2.50%. See BCB Report
  • Macro Vision: what we expect for the 1Q17 Inflation Report. The Brazilian Central Bank Monetary Policy Committee (Copom) is scheduled to publish its first Inflation Report (IR) for 2017 this coming Thursday. The IR will likely corroborate signs of intensification in the monetary easing cycle indicated by recently issued official documents. In the baseline scenario, we expect inflation forecasts to be at 3.6% for 2017 and 3.5% for 2018. In the market scenario, which is considerably more relevant in this stage of the cycle, we expect inflation forecasts to be at 4.0% for 2017 and 4.5% for 2018. We believe that the forward looking inflation scenario supports our expectation of a 100-bp cut in the benchmark Selic rate in April. Full Report
  • BCB placed the full offering of 10,000 FX swaps. After closing, the Central Bank called a roll over auction of up to 10,000 contracts on March 28. 
  • Activity has been resilient in spite of all the shocks facing the economy. The deterioration of bilateral relations with its top trading partner (U.S.) and the sharp rise of inflation (caused by the liberalization of gasoline prices and the MXN sell-off) have deteriorated the growth outlook. However, the monthly GDP proxy (IGAE) expanded by 3.0% y/y in January – above our forecast (2.3%) and market expectations (1.9%) – lifting the 3-month moving average growth rate to 2.9% y/y (December: 2.4%). At the margin, GDP gained 0.3% from the previous month, bringing the quarter-over-quarter annualized growth to 3.7% (December: 3.5% q/q). Service sectors grew, at the margin, 4.1% q/q in January (December: 4.4%), in spite of a significant deterioration of retail sales during the same month. On the industrial side, growth was 1% q/q In January (December: 0.9%). Looking at the breakdown of industrial sectors, we highlight that manufacturing output grew 6.8% q/q (December: 4.8%). 
  • We expect GDP growth to slow down to 1.6% in 2017 (2016: 2.3%), with weaker consumption and investment partly offset by firmer exports. Services would weaken amid headwinds for consumers; namely, lower real wages, tighter macro policies and lower confidence. Construction and mining (largely oil output) will likely be hurt by the fiscal consolidation. Conversely, the pick-up of U.S. industrial production and a competitive real exchange rate is already boosting manufacturing, which will provide some cushion to the economy. In fact, if uncertainty over protectionism in the U.S. fade quickly, Mexico’s GDP may slow down by less than we expect, especially considering the dynamism of U.S. activity and the degree of openness of the Mexican economy. At the margin, manufacturing exports are growing at a strong pace (February: 15.6% q/q). Full Report
  • Trade deficit has narrowed substantially from the high levels of last year. Trade balance posted a USD 684 million surplus in February, narrowing the 12-month rolling deficit to USD 11.7 billion (previous: USD 13.1 billion), with major improvement in the non-energy deficit (USD 2 billion surplus, previous: USD 0.1 billion) which more than offset the further deterioration of the energy deficit (USD 13.7 billion, previous: USD 13.3 billion). Tellingly, in the first two months of 2017, the 12-month rolling non-energy balance has stood in surplus territory, for the first time in 20 years. Moreover, the total trade deficit has shrunk to less than two thirds of what was at the peak of 2016 (USD 18.5 billion in April). At the margin, however, the trade deficit widened slightly in February. The three-month, seasonally-adjusted, annualized deficit came in at USD 7.6 billion (previous: USD 6.4 billion), after improving for four consecutive months.
  • We expect the trade deficit to continue narrowing on the back of higher U.S. growth, a competitive real exchange rate and a deceleration of internal demand. Mexico’s current account deficit already narrowed substantially recently (to 1.7% of GDP in 4Q16, according to our own seasonal adjustment) and will likely continue at a moderate level this year. Full Report

Market Developments 

  • GLOBAL MARKETS: Risky assets weaken as investors took a bearish view of the US government’s ability to push tax reform and other pro-growth policies. Equity markets on the red and Treasuries tighten (10-year: -4bps to 2.37%). Global Markets Tracker
  • CURRENCIES & COMMODITIES: Oil prices were broadly stable (Brent: +0.06% to USD 50.83/bbl) and commodities traded lower (soybean: -0.44%; iron ore: -4.40%). Hence, commodity-linked currencies posted losses (Commodity FX: -0.31%). In LatAm FX, all currencies under our coverage depreciated. The CLP decreased 0.62% to 664.63/USD and the COP traded 0.73% lower to 2,919.00/USD. The MXN posted losses of 0.71% to 18.76/USD and the BRL closed at 3.1266/USD (-0.59%). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm credit spreads for the 5-year tenor traded range bound. Chilean spreads inched up 1bp to 76bps. Both Mexican and Colombian country risk were stable at 135bps and 138bps, respectively. CDS in Brazil went marginally down to 236bps (-1bp). External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bull steepened as inflation expectations decline further (see Macro Backdrop). Also, market talks of a revision of the 2017 fiscal target were dismissed by the Ministry of Planning in an emailed statement. In DI Futures, the Jan-18 decreased 6bps to 9.84% and the Jan-21 went down 2bps to 9.85%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican yields traded higher on the back of positive activity and trade data (see Macro Backdrop). In TIIE swaps, the 6-month increased 4bps to 4.04% and the 5-year increased 2bps to 7.25%. Therefore, breakevens tightened as well (1-year: +6bps to 3.35%). Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields traded range bound. In Camara swaps, the 1-year increased 1bp to 2.84% and the 5-year was flat at 3.58%. In Colombia, the curve bear flattened in the session. Chile Rates Tracker In IBR swaps, while the 3-month went up 9bps to 6.42% and the 1-year increased 4bps to 5.86%, the 5-year was broadly flat at 5.54%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, the Central Bank’s Quarterly Inflation Report (QIR) for 1Q17 will come through (Thu.). We expect the message conveyed in this QIR to leave the doors open for stronger rate cuts (we expect a 100-bp cut in April’s meeting). Then, January’s retail sales numbers will be published (Thu.). We expect a 0.4% m/m increase in core retail, whereas the broad segment will likely shrink: we expect a 0.9% decline, pulled down by weaker vehicle sales. Moreover, the final March reading of FGV’s industrial business confidence will come out (Wed.), for which the preview indicates a 3.3% rise in confidence and 0.2 p.p. rise in capacity utilization. January’s Service Sector Survey (PMS) with data on the sector’s revenues will also come through (Wed.). Ahead on the week, the nationwide unemployment rate will hit the wires (Fri.). We expect the unemployment rate to reach 13.1% in the quarter ended in February. Finally, we count on a possible release of the BCB’s monthly activity index (IBC-Br) for January. We expect a 0.1% m/m decline. The BCB’s credit report release is also relevant (Wed.). Then, the consolidated primary budget balance for February will come through (Fri.). We expect a BRL 19.6 billion deficit, with the central government result (Thu.) posting a BRL 20.6  billion deficit and regional governments and state-owned companies’ result amounting to a BRL 1.5 billion surplus (they don’t add up due to a discrepancy between the Treasury’s and the Central Bank’s expenditure accounting). Finally, the National Monetary Council is scheduled to meet to decide on the TJLP long term interest rate (Thu.). We expect no change to the TJLP in the near future, currently at 7.5%. 
  • In Mexico, the statistics institute (INEGI) will announce February’s unemployment rate (Tue.). We expect the unemployment rate to post 3.6% (one year ago: 4.2%). The Central Bank’s board will meet to decide on the reference rate (Thu.). Given the upward trend of inflation, we expect a 25-bp rate increase to 6.50%. Finally, the Ministry of Finance (“Hacienda”) will announce February’s fiscal balance (Thu.). We expect the fiscal deficit indicators to continue narrowing, as fiscal consolidation is implemented. 
  • In Chile, the national statistics agency (INE) will publish the industrial activity indicators for the month of February (Thu.). We expect manufacturing production to contract 3.3% from last year (January: -1.1%), negatively affected by metal related manufacturing amid a prominent mining strike. Then, the central bank will publish the minutes from the March monetary policy meeting (Fri.). In the meeting, the board of the central bank cut the policy rate by 25-bp to 3.25%, in line with expectations. Also, INE will publish the national unemployment rate for the quarter ending in February (Fri.). We expect to see some further evidence of labor market loosening with an increase in the unemployment rate to 6.3% from 5.9% in the equivalent period last year. 
  • In Colombia, the national unemployment rate for the month of February will be released (Fri.). The labor market has shown continued signs of loosening through the low quality of job creation and the rise in discouraged workers. We expect the labor market to remain weak ahead amid low dynamism of the Colombian economy. 

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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