Itaú BBA - Copom delivers a 100-bp cut, as expected

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Copom delivers a 100-bp cut, as expected

May 31, 2017

The Copom took the widely expected decision, cutting the Selic to 10.25%, without a bias, in an unanimous version.

With information available until 6:30pm Brasilia time


  • The Copom took the widely expected decision, cutting the Selic to 10.25%, without a bias, in an unanimous version. The Copom signaled that the next move is probably going to be a 75-bp rate cut, which would take the Selic to single digits for the first time since 2013. We expect the Copom to cut the Selic to 9.5% in its July 25-26 meeting , and to take the base rate to 8% by year end – although the inflation forecasts discussed in the meeting statement point towards a slightly higher 2017 terminal rate. 
  • Mexican breakevens tightened past the 4-year (4y1y: -5bps to 3.85%) after Banxico’s 2Q17 inflation report brought a tougher tone (see Macro Backdrop). The MXN is strengthening 0.42% to 18.62/USD after the US secretary of commerce Wilbur Ross said “the first guiding principle of Nafta revamp is do no harm”. 

Macro Backdrop

  • The nation-wide unemployment rate reached 13.6% in April, slightly below our estimate (13.7%) and the median of market expectations (13.8%). The indicator rose 2.4 p.p. from 11.2% one year ago. Applying our seasonal adjustment, the unemployment rate was stable at 13.2%. The labor force was unchanged at the margin and expanded 1.2% yoy. Employment advanced 0.1% during the month and is 1.5% lower than in April 2016. However, formal jobs in the private sector declined 0.4% at the margin, so that the gain in employment was driven by more people taking jobs as household help and by self-employment. The seasonally-adjusted participation rate (ratio of the labor force to the working-age population) slid 0.1 p.p. to 61.5%, nearing its historical average (61.3%). The real wage bill shrank 0.1% mom/sa, but continued to show improvement in year-over-year terms, rising 0.8% in April (March: 0.6%). Full Report
  • According to ABRAS, supermarket sales fell 1.9% mom/sa in April (using our calculation). The most recent data interrupted a sequence of three consecutive gains. IBGE will release its monthly survey of trade for April on June 13, and we forecast a 1.6% mom/sa decrease in core retail sales. The broad segment, which includes vehicle sales and construction material, will shrink less: we expect a 0.3% decline. 
  • The central bank published the second quarterly inflation report of 2017, with an updated outlook that reflects the staff’s views of higher inflation and a more moderate slowdown of activity (this year). The staff now sees inflation “considerably” above the tolerance range around the Central Bank’s target in 2017 (rather than just above), and core inflation exceeding  4% (instead of 3%). On activity, Banxico revised up its GDP growth forecast for 2017 to 1.5%-2.5% (from 1.3%-2.3%), given solid growth in 1Q17 (1.8% year-over-year), and kept the forecast for 2018 unchanged (1.7%-2.7%). Nevertheless, the report features a box in which the staff argues that private investment is already weakening in response to the uncertainty surrounding trade relations with the US. In addition, the central bank argued that the real ex-ante interest rate (defined as the policy rate minus 12-month inflation expectations), now at 2.9%, is within the range of their long-term neutral rate estimates (whose upper bound is 3.3%). However, in the report (and Governor Carstens in his presentation) focused on the long-term measures, suggesting that in the central bank’s view the policy rate can rise a bit further before monetary policy becomes tight (and therefore hurts economic growth). 
  • In our baseline scenario, we see only two additional interest rate hikes in 2017 (the next one in June). However, given that the economy is performing better than expected, inflation is still on the rise and becoming more widespread, and the Fed will likely continue to raise interest rates, the risk is that the central bank increases rates by a bit more than we expect, especially considering that its policymakers do not see the current level of the real monetary policy rate as tight. Full Report
  • Fiscal accounts continued improving in April, even if the effect of the Central Bank’s dividend is excluded, which reduces the risks of sovereign risk downgrade. Over the past years, the MXN depreciation has created exchange rate gains on international reserves - MXN 31 billion in 2015 (0.2% of GDP) and MXN 239 billion in 2016 (1.2% of GDP) - reaching a record-high of MXN 322 billion this year (1.6% of GDP). Still, the improvement of the fiscal accounts goes beyond the abovementioned windfall effects. In fact, excluding 70% of the amount of the dividends from the time series (as the rest is directed to stabilization/sovereign funds, and therefore recorded as both revenues and expenditures), the 12-month rolling primary deficit narrowed to 22 billion (0.1% of GDP) in April from 24.5 billion in March, while the public sector nominal defic it widened a bit - to MXN 538.4 billion (2.6% of GDP) from MXN 525.6 billion - during the same period. Also excluding dividends, the public sector borrowing requirements - that is, the broadest measure of the fiscal deficit - stood broadly unchanged at MXN 620.9 billion (3% of GDP). Net debt and gross debt are falling in terms of GDP, and now stand at 45% of GDP and 48.1% of GDP, respectively. Full Report
  • The labor market’s continued signs of loosening are in line with our poor outlook for consumption growth. The unemployment rate for the quarter ending in April increased 0.3 p.p. to 6.7% over the 12-month period (our call: 6.8%; market consensus: 6.7%). Total job growth came in at 1.4%, stable from the 1Q17 (4Q16: 1%), while the labor force grew 1.7%, from 1.8% in 1Q17 (4Q16: 1.3%). Job creation is also being led by government-related employment (4.7% year over year), directly in public administration (18 thousand) as well as health and education posts (20 thousands). This is in line with the front loading of fiscal expenditure seen in 1Q17, however, with fiscal tightening expected ahead, public sector job growth will likely moderate ahead. We note that construction went back to destroying jobs (13 thousand) after a temporary uptick in 1Q17. As salaried employment in the private sector is performing poorly (-0.4%), total salaried employment grew only 0.3% year over year (although this represents an improvement from the -0.4% recorded in 1Q17). Meanwhile, self-employment remains the main engine behind job growth, as it expanded 5.0% (1Q17: 6.6%; 4Q16: 4.6%). 
  • With the economy continuing to show signs of weakness and the fiscal boost unlikely to last, we expect the labor market to remain feeble in the months ahead. We expect the unemployment rate to average 7.0% this year (2016: 6.5%). Full Report
  • In the quarter ending in April, the national unemployment rate came in at 9.7%, similar to that recorded in the previous year. The figure was favored by the 8.9% recorded in the month of April (in line with our estimate), the lowest April print on record. When seasonal factors are accounted for, the national unemployment rate inched down to 9.2% in the moving quarter, from 9.4% in 1Q17 (while stable from last year’s corresponding period). As has been the case in recent months, there was diverging behavior between rural and urban areas, with the unemployment rate in the latter reaching 10.8% in the quarter ending in April, almost a full percentage point up from one year ago. The difference is likely due to the strength in the agricultural sector in the absence of adverse weather this year. Of the 336 thousand jobs created, the manufacturing sector added 187 thousand (+0.9 p.p. contribution to total growth). The majority of these jobs are likely related to the revival in the agricultural sector (which added 99 thousand jobs), as urban manufacturing employment shrunk by 55 thousand. The 64.2% participation rate for the quarter ending in April inched up from one year prior, the first improvement in over one year.
  • The expected weakness in the labor market going forward would likely be limited by the recovery in agriculture and related manufacturing industries. Meanwhile, disappointing activity and the need for fiscal consolidation would be more clearly reflected in urban labor dynamics. Full Report
Market Developments 
  • GLOBAL MARKETS: Commodities posted gains as China’s manufacturing PMI came in at 51.2, higher than our call (50.9) and market consensus (51.0), remaining at high levels. In our view, PMI is likely to continue to moderate ahead, due to the gradual tightening in policy occurring in China. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Copper prices increased (+0.84%) after China’s stronger than expected PMI. Oil prices pared daily losses (WTI: -1.75% to USD 48.79/bbl) after the API report showed crude supplies fell 8.67 million bbl last week. In LatAm FX, all currencies under our coverage posted gains. The COP was the laggard, closing at 2,918.92/USD (+0.09%). The MXN is strengthening 0.42% to 18.62/USD after the US secretary of commerce Wilbur Ross said “the first guiding principle of Nafta revamp is do no harm”. The CLP, on the back of higher copper prices and lower oil prices, posted gains of 0.34% to 672.55/USD. At last, the BRL appreciated 0.96% to 3.2270/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm Credit spreads for the 5-year tenor were mixed. Colombian and Mexican spreads went up 2bps to 128bps and 119bps, respectively. Country risk in Chile stood flat at 71bps. Meanwhile, CDS in Brazil inched down 1bp to 236bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Before the Copom decision, the Brazilian curve bull flattened as the BRL appreciated. In DI futures, the Jan-18 went down 6bps to 9.25% and the Jan-21 narrowed 12bps to 10.30%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican rates were mixed in the session. In TIIE swaps, the 1-year stood flat at 7.56% while the 10-year narrowed 3bps to 7.61%. However, breakevens tightened past the 4-year (4y1y: -5bps to 3.85%) after Banxico’s 2Q17 inflation report brought a tougher tone (see Macro Backdrop). Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, the curve bull flattened as the CLP strengthened. In Camara swaps, the 1-year fell 1bp to 2.47% and the 5-year narrowed 5bps to 3.45%. Chile Rates Tracker In Colombia, yields traded lower in the session. In IBR swaps, the 1-year fell 1bp to 5.20% while the 4-year narrowed 5bps to 5.13%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, this year’s first-quarter GDP figure will be the main highlight on economic activity (Thu.). We expect a 1.1% quarter-over-quarter seasonally adjusted increase, the first positive figure since 4Q14. In addition, April’s industrial production will be released (Fri.), for which we expect a flat figure, seasonally adjusted. Also to be released is FEBABRAVE’s vehicle sales for May (Thu.). On external accounts, we expect May’s trade balance (due Thu.) to once again post a strong surplus (USD 7.0 billion) in May, topping the surplus of USD 6.4 billion in May last year. 
  • In Mexico, Banxico will publish the minutes of May’s monetary policy meeting (Thu.). We believe the minutes are likely to show more hawkish views on inflation, at least from some board members. Also, the Central Bank will publish May’s Economist Survey (Thu.). We expect an increase in both GDP growth and inflation expectations for 2017, given the upward surprises in the latest data. 
  • In Chile, the central bank will publish the minutes from the May monetary policy meeting (Fri.). Given the weak economy and low inflation, we expect the minutes to shed some light on the circumstances that could lead the central bank to reopen the doors for rate cuts.  Finally, the national statistics agency (INE) will publish the private consumption activity indicators for April (Fri.). We expect the commercial activity index to have increased 1.0% from last year (+4.9% previously).
  • In Colombia, DANE will publish export data for April (Fri.). We expect exports to come in at USD 2.6 billion, representing annual growth of 7.9%, lifted by oil exports.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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