Itaú BBA - Chilean rates narrow after big downward CPI surprise

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Chilean rates narrow after big downward CPI surprise

July 7, 2017

The Chilean curve bear steepened as CPI came in below the floor of expectations.

With information available until 6:30pm Brasilia time

Highlights

  • The Chilean curve bear steepened as CPI came in below the floor of expectations (see Macro Backdrop). In Camara swaps, the 1-year fell 9bps to 2.37% and the 10-year went down 4bps to 4.12%. The CLP depreciated 0.22% to 667.25/USD.
  • Elsewhere in LatAm FX, currencies posted gains after the US labor report. The MXN outperformed among the majors, trading 0.92% stronger to 18.09/USD. Then, the COP posted gains of 0.20% to 3,088.37/USD. The BRL closed at 3.2811/USD (+0.53%). 
  • In our Monthly Strategy report, we argue that soft inflation and stable growth in DM still favor LatAm assets, but oil poses risks for Mexico and Colombia. The long end of the Mexican curve compressed strongly after Banxico signaled the end to the tightening cycle. However, we see limited room for further narrowing, as the Mexican government will have less leeway to mitigate the fiscal impact of the oil rout. Also, the deterioration in Colombia’s fundamentals will put pressure on credit spreads and long yields ahead. 

Macro Backdrop

BRAZIL
  • IPCA prints deflation of 0.23% in June. The figure came in slightly below our call (-0.17%) and the median of market expectations (-0.19%). The biggest deviation from our forecast came from market-set prices in the industrial sector, which more than offset the higher-than-expected print for services. The IPCA had climbed 0.31% in the previous month and 0.35% in June 2016. In the first half of 2017, the IPCA has climbed 1.18%, far below the 4.42% reported during the year-earlier period. According to the IBGE, this was the lowest year-to-date rate for the first semester since 1994. The year-over-year IPCA rate retreated to 3.00% after reaching 3.60% in May. Breaking down by product groups, the downward contribution during the month came from housing (-0.12 p.p.), food and beverages (-0.12 p.p.), and transportation (-0.09 p.p.). On the other hand, the biggest upward contribution came from healthcare and personal care (0.05 p.p.), with the biggest impact coming from insurance plans. 
  • Our preliminary estimate for the IPCA in July is for an increase of 0.18%, which will lead to a new decline in the year-over-year rate, to 2.7%. The biggest contribution to the increase will come from electricity, reflecting the activation of the yellow flag at the beginning of the month, as well as the tariff adjustments at some utilities with a relevant weight in the IPCA. On the other hand, the transportation group is likely report negative rates for the fifth month in a row due to new declines in the price of fuels. Full Report
  • Paper cardboard dispatches (ABPO) rose 0.2% mom/sa in June (our seasonal adjustment), up 2.4% yoy. It is one of the two most important coincident indicators for industrial production (the other is traffic of heavy vehicles). The result is better than other industrial production coincident indicators already released, so we raised our industrial production forecast to -0.2% mom/sa in June (before ABPO’s release: -0.8%). 
  • The Serasa Experian Index for Retail Activity rose 1.2% mom/sa in June (official seasonal adjustment), following a 0.6% increase in the previous month. The index shows a gradual increase year-to-date, following stable figures through 2016 and a steep decline in 2015. The breakdown shows declines in supermarkets (-0.4%) and “apparel” (-2.1%), and positive figures for the other components. Combining with other indicators, our preliminary forecasts for June core and broad retail sales stand at -0.1% and 1.7% mom/sa, respectively. 
  • After closing, the BCB called for a rollover auction of up to 8,300 FX swaps on July 10. If this pace is maintained throughout the month, the Central Bank will have rolled over the entire lot due in August (USD 6.2 billion). 
MEXICO
  • Inflation continued increasing in June, pressured by the volatile non-core prices, but inflation fell at the margin. The CPI posted a 0.25% monthly variation in June, in between our forecast (0.20%) and median market expectations (0.27%). Agricultural prices, which usually drop in 2Q17 because of seasonality, increased by 0.42% month-over-month, exceeding its 5-year median variation (-2.12%) by six times. Core goods and core services prices advanced 0.32% and 0.29%, respectively, contributing 11bps and 12bps to the monthly print. Conversely, the drop of gasoline prices (-0.6%) exerted downward pressure. We note that on June 15, in accordance with the liberalization calendar set by the Energy Regulatory Commission (CRE), gasoline prices were fully freed in the states of Chihuahua, Coahuila, Nuevo León, Tamaulipas, and the municipality of Gómez Palacio (state of Durango), which together account for approximately 16% of gasoline consumption in Mexico. Headline inflation increased to 6.31% year-over-year (from 6.16% in May), while core inflation increased by less (to 4.83%, from 4.78% in May) during the same period. Also, we note that a diffusion index increased to 77.2% in June (from 75.2% in May).
  • We expect annual inflation to decrease to 5.4% by the end of 2017. Although non-core inflation has surprised to the upside and diffusion indexes remain on the rise, we believe that disinflation will begin in the coming months, mainly on the back of the lagging effects of MXN appreciation (12%-year-to-date, more than half-way of erasing the 19% depreciation observed in 2016). Weaker activity and lower international oil (and gasoline) prices will also be important to bring inflation down. Full Report
CHILE
  • Consumer prices came in well below market expectations in the month of June. Inflation dropped below the lower bound of the central bank’s 2%-4% tolerance range to 1.7% yoy (previous: 2.6%) and is the lowest annual inflation since October 2013. This is below the 2.1% market consensus and our 2.0% forecast. The continued decline in tradable inflation, favored by a stable CLP, remains the main drag on consumer prices; however, non-tradable inflation also fell substantially, standing at its lowest level since July 2013. Prices fell 0.4% from May to June, below the 0.4% gain recorded one year ago (consensus: 0%; our call: -0.1%). The surprise was concentrated in a handful of products. The larger than expected reversal of tourism package prices (-15% and contributing 0.14 p.p. to the total monthly fall), alongside the 9.9% drop in air-travel explain over half of the surprise. Given the drop in tourism packages, the recreational goods division was the main drag in the month (-0.16 p.p.), followed by food and non-alcoholic beverages (-0.13 p.p., led by lemon and tomato prices) as well as apparel (-0.06 p.p.). 
  • We do not expect the central bank to act on low inflation just yet, but if activity fails to show signs of a recovery in the second half of the year, the board will likely re-evaluate its stance. We see the policy rate stable at 2.5% this year, but given the recent evolution of inflation and activity, there are risks of further interest rate cuts. Finally, we revised our yearend inflation forecast to 2.4%, from 2.8% previously. Full Report
  • In spite of recovering mining exports, improved consumer and capital imports in the second quarter of the year led to a smaller trade balance. The USD 58 million surplus in June (USD 50 million market consensus; Itaú: USD 100 million) came in below the USD 375 million recorded one year ago as consumer goods imports continue to increase. The rolling 12-month trade surplus came in at USD 3.9 billion, inching down from the USD 4.3 billion as of 1Q17 (USD 5.3 billion in 2016). Nevertheless, the trade balance remains at a comfortable level and the mining export recovery is expected to continue (as production recovers with the end of a strike in the sector), while lower global oil prices will aid an increase in the trade balance. Our seasonally adjusted series shows that, at the margin, the trade balance surplus picked up to USD 1.7 billion (annualized) in 2Q17, from the USD 1.1 billion annualized surplus recorded in 1Q17, as mining exports return to normality. An improvement of the trade balance in the months ahead is expected. We expect the current-account deficit to stay broadly stable from last year, at 1.2% of GDP. Full Report
Market Developments 
  • GLOBAL MARKETS: Non-Farm Payroll rose 222k in June, above expectations (consensus: 178k; Itaú: 200k) and consistent with continued decline in the labor market slack. Despite the economy seemingly at full employment, wage pressures remains muted, allowing the Fed to keep a gradual pace of tightening (September: balance sheet reduction; December: rate hike). However, average hourly earnings rose 0.16% m/m, well below our expectation (0.34%) and was revised down to 0.1% (from 0.2%) in the prior month. Hence, the average hourly earnings remained at 2.5% YoY (and now it looks like it will take longer to rise). The Fed funds implied probability of a rate hike in September fell to 16.1% from 22.1% as of Thursday. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities posted losses, even with iron ore prices increasing 2.18% and soybean +1.63%. The main drag was the drop in oil (WTI: -2.61% to USD 44.33/bbl) as Baker Hughes reported the oil rig count rose by 7 this week. In LatAm FX, most currencies posted gains after the batch of data in the US. The MXN outperformed among the majors, trading 0.92% stronger to 18.09/USD. Then, the COP posted gains of 0.20% to 3,088.37/USD. The BRL closed at 3.2811/USD (+0.53%). Bucking the regional trend, the CLP depreciated 0.22% to 667.25/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm country risk narrowed in the session. For the 5-year tenor, Chilean and Colombian spreads inched down 1bp to 67bps and 142bps, respectively. In Mexico, CDS fell 2bps to 114bps and in Brazil they went down 3bps to 242bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Long Brazilian yields widened ahead of the weekend. In DI futures, while short rates (until Apr-18) inched down 1bp, long ones went up (Jan-21: +5bps to 10.01%). Conversely, breakevens widened as the 3-year increased 5bps to 4.37%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Long Mexican yields narrowed 8-9bps in the session. In TIIE swaps, the 1-year fell 2bps to 7.26% and the 5-year went down 9bps to 6.84%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: The Chilean curve bear steepened as CPI came in below the floor of expectations (see Macro Backdrop). In Camara swaps, the 1-year fell 9bps to 2.37% and the 10-year went down 4bps to 4.12%. Chile Rates Tracker In Colombia, rates widened in the session once again. In IBR swaps, the 1-year increased 5bps to 5.01% and the 4-year widened 1bp to 5.29%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, the rapporteur of the criminal charges against President Michel Temer in the Lower House’s Constitution and Justice Committee is expected to release his report (Mon.). The case against President Temer is likely to dominate the debate in the Lower House, and may possibly be voted by the Committee before the end of the week. In the meantime, the Senate is expected to approve the labor reform (Tue.). On the macro agenda, the key releases for the week will be May’s retail sales (Wed.) and the Service Sector Survey (PMS) (Thu.). We forecast a 0.1% decline in core retail (month-over-month, seasonally adjusted), and a 0.9% drop in the broad segment, which includes vehicle sales and construction material. May’s PMS is also relevant for 2Q17 GDP estimates - we expect the headline to fall 2.3% year-over-year. Furthermore, the BCB will release its monthly activity index (IBC-Br) for May (Fri.). Also, IBGE will release the monthly update of its Systematic Survey of Agricultural Production (Tue.).
  • In Mexico, the National Association of Department Stores and Supermarkets (ANTAD) will announce June’s same-store-sales (Tue.). We expect the growth of ANTAD sales to slow down moderately (to 5% year-over-year, from 5.7% in May). Then, the statistics institute (INEGI) will publish May’s industrial production (Wed.). We expect industrial production growth to pick up to 0.1% year-over-year (from a 4.4% contraction in March), led by stronger manufacturing output. In fact, several coincident indicators of the manufacturing sector – mainly, manufacturing exports, vehicle production, PMI – strengthened in May. Conversely, we expect a contraction of construction output, considering the sharp fall of public investment in May (physical capital investment down by 23.9% year-over-year in real terms). Also, we already know that oil output continued contracting. 
  • In Chile, the central bank will hold its July monetary policy meeting (Thu.). In spite of weak activity and surprisingly low inflation in the month, we believe the board will once again stay on hold this month as it opts to evaluate how the economy unfolds given the monetary stimulus already implemented (100bps in cuts since January).
  • In Colombia, activity indicators for the month of May will be published (Fri.). We expect industrial production to increase 2.0% year over year (-6.8% in April). Meanwhile, retail sales likely saw growth of 1.4% in twelve months (-2.0% previously), boosted by car sales. Heavy rains and a port strike could have hampered activity in the month. Also, the central bank of Colombia will release the minutes of the monetary policy meeting held in June (Fri.). At the meeting, another split board decided to cut the policy rate by 50bps to 5.75%, more aggressive than the 25bp cut in the previous month. It will be of interest to see if the minutes reiterate recent comments from the central bank’s general manager, as well as the finance minister, who have both indicated that room for further easing is narrowing.
  • In Argentina, the INDEC (the official statistical agency) will publish the CPI for June (Tue.). In addition to the current index (which covers the Greater Buenos Aires area), INDEC will release a national CPI, which will also be the target of the central bank. According to private surveys, headline inflation in the Greater Buenos Aires area hit 1.4% mom (22% yoy), while the core measure was above the headline level. We do not expect the National CPI to deviate significantly from inflation in the Greater Buenos Aires area. Then, the central bank will hold its biweekly monetary policy meeting, to decide on the reference rate (Tue.). We expect prices to remain under pressure on July due to adjustments in fuel and health prices and the recent depreciation of the peso. Given these developments, we do not expect a rate cut in July. 

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Today's editors: Eduardo Marza, Pedro Correa




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