Itaú BBA - BRL back to the 3.14/USD handle

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BRL back to the 3.14/USD handle

July 19, 2017

The Brazilian curve bull flattened amid a stronger BRL.

With information available until 6:30pm Brasilia time


  • The Brazilian curve bull flattened amid a stronger BRL. In DI futures, the Jan-18 fell 4bps to 8.60% and the Jan-21 went down 9bps to 9.49%. Likewise, real yields narrowed as the Aug-20 went down 8bps to 4.75%. Also, Brazilian CDS narrowed 5bps to 216bps and the BRL closed at 3.1488/USD (+0.24%) – its strongest level since May 17. 
  • Elsewhere in LatAm FX, the MXN is trading 0.49% weaker to 17.5606/USD. The COP appreciated 0.26% to 3,004/USD and the CLP posted gains of 0.28% to 653.69/USD. 

Macro Backdrop

  • Tax collection came at BRL 104.1 billion in June, roughly in line with our call (BRL 103.8 billion) and a little better than market expectations (at BRL 102.8 billion). Tax collection returned to the black ink (2.9% y/y in real terms) after a weak result last month (-1.0% y/y), confirming an increasing trend compared to last year (0.8% ytd). Tax collection is close to stability in real terms. Excluding tax amnesty programs (REFIS/PRT), tax collection is rising 1.4% y/y in the 3-mma. We believe a strong tax collection rebound is unlikely, especially considering that indicators that matter the most for tax collection (real wage bill and retail sales) will underperform GDP. As so, complying with the 2017 central government primary target of a 139 BRL billion deficit should prove itself a very challenging task in the absence of significant surprises in extraordinary revenues, tax hikes or further cuts in discretionary spending. The central government primary result from June will be released next week, for which we expect a BRL 20.6 billion deficit. 
  • The BCB placed the full offering of 8,300 FX swaps. After closing, the central bank announced another roll over auction of up to 8,300 contracts (USD 415 million) on July 20. 
  • S&P revised Mexico’s credit rating outlook (to stable, from negative), arguing that fiscal accounts are improving and downward risks on economic growth are moderating, which is contributing to buttress the positive sentiment on the Mexican economy. Back in 2016, the three main rating agencies – Moody’s (March), S&P (August), and Fitch (December) – announced downward revisions of Mexico’s credit outlook (to negative, from stable) highlighting concerns over fragile public finances (particularly rising debt) and headwinds on GDP growth. We note that Moody’s (A3) actually rates Mexico one notch above than S&P (BBB+) and Fitch (BBB+). The S&P agency becomes the first rating agency to revert its previous decision. According to the press release, S&P now expects the general government debt to hover around 45% of GDP in 2017, which would mark the first decrease in the public-debt-to-GDP ratio in 10 years, and remain below 50% in the next two years. On economic activity, S&P sees GDP growth a little below 2% in 2017, and picking up to 2%-3% during 2018-2019, stressing that their base-case scenario implies that NAFTA will be renegotiated in such a way that trade relations between Mexico, the U.S., and Canada will be preserved, to great extent, supporting the economies of the region. Also, interestingly, S&P argues that even though the next President could bring about a change in spending priorities, they expect prudent monetary and fiscal policies (the latter focused on containing the public debt) to remain in place. 
  • The Mexican government has welcomed the news, and re-affirmed that they will continue implementing their fiscal consolidation efforts in 2018. Finance Minister Meade stated that S&P’s announcement reflects a “vote of confidence on the macroeconomic fundamentals and the good performance of the economy”. Deputy Finance Minister, Vanessa Rubio, indicated that there will be no complacency, as the government is poised to continue implementing the fiscal consolidation plan and further budget cuts cannot be ruled out. More budget cuts, in other words, would mean more ambitious fiscal targets compared to the ones laid out in the fiscal consolidation plan. As per the budget plan presented last year in September (and updated in April 2017 in the pre-budget document, “pre-criterios”), the government is targeting to decrease public sector borrowing requirements (the broadest measure of the fiscal deficit) to 2.5% of GDP in 2018, from 4.6% of GDP in 2014 (before the fiscal consolidation began). The Ministry of Finance (“Hacienda”) estimates that in 2017 the PSBR will post 1.4% of GDP (surpassing the target set for 2017, 2.9% of GDP, largely because of the large dividend received from the Central Bank). To achieve the fiscal target set for 2018 – that is, officially, a PSBR of 2.5% of GDP, with implied assumptions of a public deficit of 2% of GDP and a primary surplus 1% of GDP – the government cannot backtrack on its commitment to deliver fiscal consolidation (in an electoral year), because there will be no windfall revenues of a Central Bank dividend in 2018. The deadline to present the bill of the 2018 budget, which will reveal if the government decides to step up its fiscal consolidation efforts, is September 8.
  • The 12-month rolling deficit kept narrowing in May, but dynamics at the margin shows a deficit stabilizing at a still high level. The trade deficit came in at USD 186 million in May, in line with our forecast and smaller than market consensus of USD 250 million. The deficit is smaller than the USD 685 million deficit recorded one year ago. As a result, the rolling 12-month trade deficit narrowed to USD 9.7 billion, from the USD 10.0 billion as of 1Q17 (and down further from USD 11.5 billion in 2016 and USD 15.6 billion in 2015). The narrowing is due to the continued improvement in the energy balance, while the non-energy balance deficit remains sticky. However, at the margin exports are deteriorating due to lower oil prices while imports are expanding, bringing the three-month trade deficit to USD 10.6 billion (seasonally-adjusted and annualized), from USD 9.0 billion in 1Q17 (USD 7.7 billion in 4Q16), mostly due to a narrower energy balance. Imports (FOB) increased 4.2% year over year in May (8.8% previously), resulting in a 9.4% rise in the quarter ending in May (+7.0 in 1Q17 and -8.4% in 4Q16). Total exports rose 23.5% year over year (6.5% in April), with coal exports at the forefront. 
  • Overall, the data confirms that Colombia’s external accounts improvement at the margin has halted and remains at uncomfortable levels. We forecast a current account deficit of 3.7% of GDP this year (4.3% in 2016). Lower oil prices limit the current account deficit correction, in spite of internal demand weakening. Full Report
  • In its most recent monetary policy report, the central bank emphasized the progress on disinflation, highlighting the fall of year-over-year inflation since the beginning of the year (36.6% to 21.7% in June). At the same time, the central bank called attention to the fact that lower inflation is coming together with higher and more broad-based economic growth. In this context, the bank highlighted in the report that quarter-over-quarter growth has been positive and increasing since 3Q16 and, based on available indicators, the bank expects a 4.0% annualized rate in 2Q17. Furthermore, all demand components expanded between 4Q16 and 1Q17 and, according to a “heat map” developed by the staff of the central bank, the proportion of sectors showing an above-average expansion is rising. On the inflation front, market expectations point to a continuous disinflation process over the next years, although more slowly than targeted by the central bank. The evolution of wholesale prices also suggests disinflation will continue, according to the report. Still, it doesn’t seem that the central bank is ready to embark on an easing cycle yet. When presenting the report, Governor Federico Sturzenegger said the persistence of core inflation is the central bank’s main concern. Once again the central bank attributed the higher-than-targeted core inflation to premature monetary easing in late 2016.
  • Although we expect the central bank to cut interest rates in the second half of 2017, the still high levels of inflation combined with uncertainty related to the mid-term elections mean the easing process will likely be gradual. In this context, there are upside risks to our 22% forecast for the policy rate by the end of this year. Full Report
  • Treasury Minister Nicolás Dujovne announced in a press conference the achievement of the primary fiscal deficit target during the first half of the year. The primary fiscal deficit reached ARS 144.3 billion and -1.5% of GDP in 1H17, below the -2.0% target for the period.  However, primary fiscal deficit worsened in June, relative to 2016. The primary balance came in at a deficit of ARS 57.0 billion in June, compared with a deficit of ARS 44.0 billion registered in the same month of 2016. Accumulated over the last 12 months, it rose to ARS 375 billion in June, from ARS 362 billion in May. According to our estimates, the deficit rose to 4.1% of GDP (from 4.0% in May) but is in line with the treasury’s 2017 target of 4.2%. Expenditures increased by 26% YoY, while total revenue grew 24% YoY, both surpassing the 21.7% inflation rate registered in the previous 12 months.  
  • We expect the government to meet its official target deficit of 4.2% of GDP in 2017. But meeting the 2018 target (-3.2% of GDP) will be more challenging, especially considering the absence of resources related to the tax amnesty. Full Report
Market Developments 
  • GLOBAL MARKETS: Ahead of the ECB and the BoJ, markets traded in a risk on tone, with equity markets on the green and decreased volatility. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Oil prices went up (WTI: +1.46% to USD 47.27/bbl) as EIA’s weekly report showed US crude inventories registering another bigger-than-expected drop. Agriculture commodities posted gains as soybeans strengthened 1.04% and sugar +2.84%. Metals, on the other hand, were mixed as copper fell 0.84% and iron ore increased 1.37%. In LatAm FX, the MXN is trading 0.49% weaker to 17.5606/USD. The COP appreciated 0.26% to 3,004/USD and the CLP posted gains of 0.28% to 653.69/USD. At last, the BRL closed at 3.1488/USD (+0.24%) – its strongest level since May 17. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Most LatAm credit spreads fell in the session. For the 5-year tenor, Brazilian country risk narrowed 5bps to 216bps. In Mexico, spreads went down 2bps to 106bps and in Colombia they fell 1bp to 133bps. On the other hand, CDS in Chile stood flat at 66bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bull flattened amid a stronger BRL. In DI futures, the Jan-18 fell 4bps to 8.60% and the Jan-21 went down 9bps to 9.49%. Likewise, real yields narrowed as the Aug-20 went down 8bps to 4.75%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Long Mexican yields widened in the session. In TIIE swaps, while very short rates were broadly unchanged (6-month: at 7.38%), long ones went up (5-year: +4bps to 6.85%). Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, the curve shifted 2-4bps upwards. In Camara swaps, the 1-year went up 4bps to 2.43% and the 8-year widened 3bps to 3.99%. Chile Rates Tracker In Colombia, rates were mixed in the session. In IBR swaps, the 6-month narrowed 1bp to 5.15% and the 5-year widened 1bp to 5.46%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, July’s IPCA-15 consumer inflation preview will be released (Thu). We forecast a 0.08% monthly fall, with year-over-year inflation slowing to 2.9% from 3.5%. With this result, inflation will have reached 1.5% from January to July, well below the 5.2% recorded during the same time window last year. Then, FGV’s industrial business confidence preview for July will be released (Thu.). The results will be important to assess the impact of the more turbulent political scene. Moreover, the government will release its bimonthly revaluation report (Fri.), where it will update its forecasts for the 2017 primary result and may possibly announce a BRL 4 billion unfreeze on discretionary expenses. Onto the balance of payments report (Fri.), we expect a USD 1.3 billion current account surplus in June, topping last year’s deficit of USD 2.5 billion for the same month. We also expect direct investment in the country (DIC) to register inflows of USD 2.3 billion in June.
  • In Mexico, the Statistics Institute (INEGI) will announce June’s unemployment rate (Fri.). We expect the unemployment rate to post 3.5% (below the 3.9% level recorded in June 2016) indicating that labor market conditions remain tight. According to data reported by the Mexican Institute of Social Security (IMSS), formal employment has consistently grown above 4% year-over-year throughout the first six months of 2017. 
  • In Colombia, coincident activity indicator (ISE) for the month of May will be released (Fri.). The April indicator continued to reflect activity weakness as the seasonally adjusted series fell from the previous month for the fifth consecutive time. Annual year-to-date stands at 0.6% (2.7% in the 2016 equivalent period). 

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

For details on Brazilian markets, refer to our Handbook - First edition.

Today's editors: Eduardo Marza, Pedro Correa

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