Itaú BBA - Copom cuts the Selic rate by 75bps as expected

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Copom cuts the Selic rate by 75bps as expected

February 22, 2017

DI Futures tightened further. The curve shifted downwards 7bps, on average.

With information available until 6:30pm Brasilia time


  • In rates, DI Futures tightened further. The curve shifted downwards 7bps, on average. The Jan-19 inched down 7bps to 9.98%. In LatAm FX, all currencies under our coverage appreciated due to a weaker external environment. The MXN appreciated 0.63% to 19.89/USD and the CLP traded at 642.08/USD (+0.21%). The COP strengthened to 2,895.12/USD (+0.22%). The BRL overperformed its regional peers, appreciating 1.04% to 3.0646/USD.
  • Sentiment remained risk-supportive; volatility measures increased and U.S. corporate credit spreads narrowed.  Both long US Treasuries (10-year: -1bp to 2.42%) and EONIA rates (10-year: -3bps to 0.49%) narrowed, amid uncertainties on the external environment.

Macro Backdrop

  • In line with our expectation, BCB’s Monetary Policy Committee (Copom) unanimously decided to make another 75bps interest rate cut, leading the Selic rate to 12.25% p.a.. The Copom decided to cut the Selic by 75bps, to 12.25%pa, without bias, in an unanimous vote. Its statement sounds a tad more constructive on activity, which might carry a hawkish interpretation, and indicates that the inflation target would be met in 2018 (which must be the relevant policy horizon by now) with a Selic rate at 9.5% by the end of this year. The text also indicates that the cycle’s extension will depend on estimates about the "structural interest rate" (neutral rate?) of the Brazilian economy, which will be reassessed by the Copom over time. It is widely expected that given ongoing fiscal reform measures, and changes in the modus operandi of public sector banks, the non-accelerating inflation interest rate may fall in Brazil, but quantifying these effects, which in any event will only materialize over the medium-term, is quite challenging. And, lastly but importantly, the Copom explicitly leaves the door open to faster rate cuts, stating that possible intensification of easing will depend on the cycle’s extension but also on the behavior of economic activity, on risk factors (external, benign agricultural price shock, prolonged recession) and on inflation forecasts and expectations, in that order. To us, the text indicates that the pace might continue at 75bps, and this is what we expect, for now, for the coming policy meeting, on April 11/12 - with a 9.25% terminal Selic for 2017. But the text also suggests that the Copom may accelerate beyond 75bps (a) if it finds that the "structural" rate is lower and (b) activity disappoints or the other factors move in the appropriate way with the appropriate strength. So the decision remains data dependent with the twist that the combination of data in-line with expectations with new, more benign estimates of the "structural" rate might lead to faster cuts. We'll learn more about the reasoning behind the Copom decision with the release of the minutes on Thursday, March 2nd. Importantly, we reckon the coming Inflation Report, to be published on March 30th, might be quite informative on the authorities' views and modeling of the structural rate, and thus on the likely extension of the cycle and, possibly, also on the pace of coming rate cuts. 
  • February’s IPCA-15 inflation further decelerates. The IPCA-15 inflation preview came at 0.54% m/m, close to our expectations (0.52%) and the market’s (0.50%). The 12-month reading decelerated to 5.02% y/y from 5.94% y/y in January. Industrials inflation came in slightly higher than expected, with surprises spread out across industrial items. The biggest contributions to the monthly increase came from education (reflecting annual adjustments in school tuition fees) and transportation (driven by hikes in public transportation fares). On the opposite end, services inflation surprised to the downside and continued to decelerate over 12 months (to 6.1% from 6.4%). Recent price surveys have been suggesting a continuous disinflation process, which is consistent with our scenario of inflation deceleration ahead. Based on current information, we revised our forecast for the headline IPCA in February down slightly to 0.45% (from 0.47%), with the yearly change slipping to 4.9%. We expect the headline IPCA reading at 4.4% y/y by yearend. Full Report
  • Tax collection in line with expectations. Tax collection came in at BRL 137.4 billion in January, in line with market expectation (BRL 137.0 billion) and our call (BRL 137.8 billion). As the Federal Revenue Service reported, tax collection may have been positively influenced in the month by extraordinary revenues from capital gain on the sale of assets and royalties. Tax collection 3-years decline tendency in real terms is showing some relief at the margin. We believe 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. This implies that the government will need around BRL 60 billion in non -recurrent revenues to comply with 2017’s primary result target (BRL 143 billion deficit or -2.2% of GDP) as we expect. The central government primary result from January will be released Thursday. With this result, we revised our forecast to a BRL 2.0 billion surplus (from BRL 2.2 billion). 
  • Consumer confidence reaches the highest level since December 2014. Consumer confidence (FGV) increased 3.2% m/m in January (previous: 8.5%), amid rises in both the current situation component (+3.2%) and the expectations component (+2.8%). The intention to purchase durable goods was up 2.6%. The percentage of people reporting that jobs are hard to get fell for the second consecutive month (to 95.9% from 97.4%), remaining at high levels though. In all, data shows a slight upward trend in confidence in the last months, led by expectations.
  • BCB placed the full offering of 6,000 FX swaps. After closing, the Central Bank called a roll over auction of up to 6,000 contracts on February 23. 
  • The economy pulled off a solid 4Q16. The monthly GDP proxy (IGAE) expanded by 2.1% y/y in December – above our forecast (1.8%) and market expectations (1.7%) – leaving the GDP growth rate of 4Q16 at 2.4% y/y (beating the 2.2% flash estimate announced three weeks ago). Adjusting for calendar effects, GDP growth was also 2.4% y/y (3Q16: 2.1%). At the margin, GDP expanded 0.7% q/q sa, bringing quarter-over-quarter annualized growth to 2.9% in 4Q16 (below the 4.3% q/q sa observed in 3Q16). Service sectors grew 3.2% y/y in 4Q16 (3Q16: 3.3%), underpinned by solid consumption. The volatile primary sectors (mostly agriculture) also expanded at a strong pace (6.4% y/y), providing an unanticipated tailwind in 4Q16. Meanwhile, industrial production growth remained nil during the same period. Looking at the breakdown of industrial sectors, manufacturing accelerated 1.0% y/y in 4Q16 (2Q16: 0.8%), which is consistent with the acceleration of manufacturing exports observed in the trade balance data. Construction activity also picked up (1.8% in 4Q16, 0.8% previously), but it remains negatively exposed to the government’s fiscal consolidation. Conversely, mining output deepened its contraction (4Q16: -6.4% y/y; 3Q16: -4.8%), dragged by falling oil output.
  • Annual GDP growth only slowed down moderately (2016: 2.3%; 2015: 2.6%). The constant throughout last year was robust service sectors (underpinned by strong private consumption) and weak industrial activity. The numbers for 4Q16 show that the economy has still not assimilated the headwinds that intensified in November (following the outcome of the U.S. presidential election) and are expected to hit activity in 2017. In fact, we expect a weaker performance of the economy starting in 1Q17, as higher inflation (eating through real wages), tighter macro policies (higher domestic rates and fiscal consolidation), and uncertainty surrounding trade relations with the U.S. will weigh on aggregate demand. Higher growth in the U.S., boosting Mexico’s manufacturing exports, however, might act as a buffer. We expect growth of 1.6% in 2017. Full Report
  • A stronger than expected end to 2016. Activity gained 1.6% y/y in 4Q16 (3Q16: 1.2%). This came above our 1.2% forecast and the 1.5% market consensus. The improvement is partly due to robust services and a recovery of private consumption related activity (likely ahead of an increased sales tax this quarter), while oil production remains a drag. Overall, activity in the natural resource sectors dropped 3.4% year over year in 4Q16 (-3.6% previously). In 2016, there was a 3.3% contraction (+1.3% in 2015), with oil production dropping 11.1% (+0.4% in 2015). Meanwhile, the 2.2% rise in non-natural resource sectors (in line with 3Q16) pulled activity up in the quarter. 
  • In spite of the activity pickup in the final quarter of last year, growth in 2016 was the lowest since 2009. With upside revisions (mainly to services) to the first three quarters of the year, activity grew 2.0% in 2016, above our 1.8% forecast, but still a slowdown from the 3.1% in 2015, as the impact from the terms-of-trade unfolded. However, at the margin, activity accelerated at the highest pace since 3Q15. For 2017, activity will likely show some recovery. . Higher oil prices will boost, offsetting the still-high interest rates and tighter fiscal policy. The carry-over effect from the stronger than expected end to 2016 removes the downward bias to our 2.3% growth forecast for this year. Full Report
  • Industrial confidence worsens in January. According to think-tank Fedesarrollo, industrial confidence came in at 1.9% in January (0 is neutral), below the 5.3% recorded one year ago. Industrial confidence fell 2 pp sa from the previous month into negative territory. This is consistent with the weak activity as the economy undergoes the adjustment to the terms-of-trade shock. Compared to the same month last year, all the industrial confidence components deteriorated. In particular, the volume of goods ordered component worsened to -24.8% (from: -22.5%), possibly reflecting the deteriorating current situation. On the other hand, retail confidence remains optimistic at 24.8%, an improvement from the 19.5% recorded in January 2015 and in contrast with the historical lows reached by consumer confidence. We expect confidence levels to be strained ahead as economic activity remains at low levels.

Market Developments 

  • GLOBAL MARKETS: Sentiment remained risk-supportive; volatility measures increased and U.S. corporate credit spreads narrowed. Both long US Treasuries (10-year: -1bp to 2.42%) and EONIA rates (10-year: -3bps to 0.49%) narrowed, amid uncertainties on the external environment. The Fed funds futures implied probability of a March hike decreased to 34% from 36% as of Tuesday. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities traded lower (CRB Futures Index: -0.04%) and oil prices decreased. Soybean prices went down 0.36%. Copper and Iron Ore posted losses of 0.42% and 1.38%, respectively. Brent registered losses, to USD 55.87/bbl (-1.39%). In LatAm FX, all currencies under our coverage appreciated due to a weaker external environment. The MXN appreciated 0.63% to 19.89/USD and the CLP traded at 642.08/USD (+0.21%). The COP strengthened to 2,895.12/USD (+0.22%). The BRL overperformed its regional peers, appreciating 1.04% to 3.0646/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm spreads for the 5-year tenor fell, except for Brazil. In Chile, spreads went to 76 (-2bps). The Mexican fell 2bps to 148bps. CDS in Brazil stood flat at 225bps. Colombian spreads fell the most (-3bps) to 139bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: DI Futures tightened further. The curve shifted downwards 7bps, on average. The Jan-19 inched down 7bps to 9.98% and the Jan-21 fell 8bps to 10.18%. Accordingly, real rates fell: Aug-20 went down 7bps to 5.51%.The curve implies 342bps to 385bps in rate cuts for 2017. Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve bull flattened, as long TIIE swaps tightened substantially. The 1-year fell 19bps to 7.06% and the 5-year decreased 21bps to 7.47%. The curve now implies roughly 75bps in rate hikes by YE17, from the 100bps registered Tuesday. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: Camara rates traded range bound. While short term (until 1-year) rates fell (6-month: -2bps to 3.05%), long swaps traded higher (5-year: +2bps to 3.70%). Chile Rates Tracker The IBR curve tightened substantially, as GDP data for 4Q16 came in better than expected. The 1-year fell 17bps to 6.45% and the 8-year decreased 10bps to 6.14%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, the consolidated primary budget for December is on focus. (Fri.). Also, the final industrial business confidence reading by FGV will be released (Fri.). Furthermore, the nationwide unemployment rate for January will come through (Fri.). We forecast the unemployment rate to reach 12.5%, which in seasonally-adjusted terms means unemployment will climb to 12.8% from 12.6%. Moreover, CAGED formal job creation for the same month may come through. We expect net closings of 36k jobs, which is -4k in seasonally adjusted terms. Also worthy of note, the Central Bank’s credit report will come through (Thu.). Finally, January’s tax collection may be released. We forecast BRL 137.8 billion. 
  • In Mexico, CPI inflation figures for the first half of February will be published (Thu.). We expect bi-weekly inflation to post 0.32%. Then, Banxico will publish (Thu.) the minutes of February’s monetary policy meeting. INEGI will announce December’s retail sales (Fri.). We estimate that retail sales growth at 6.8% y/y. Finally, the Central Bank will publish Q4’s current account balance (Fri.). We expect the current account deficit at USD 4.4 billion in 4Q16. 
  • In Colombia the central bank will hold its second monetary policy meeting of 2017 (Fri.). We expect the central bank to stay on hold at this meeting. 

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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