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International tension weighs on LatAm FX

August 9, 2017

Geopolitical concerns in the Pacific region fuel risk aversion in global markets.

With information available until 6:30pm Brasilia time

Highlights

  • Geopolitical concerns in the Pacific region fuel risk aversion in global markets. Hence, LatAm FX (-0.65%) posted losses. By the time of writing, the MXN is trading 0.52% weaker to 17.9440/USD. The COP depreciated 0.19% to 3,002/USD and the CLP was stable at 648.14/USD (+0.05%). The BRL was the laggard within high-beta pairs, closing at 3.1557/USD (-0.93%). 
  • Mexican rates widened as headline inflation came in above the most pessimistic forecast (see Macro Backdrop). In TIIE swaps, the 1-year increased 3bps to 7.36% and the 5-year went up 4bps to 6.95%. The implied inflation term structure flattened: the 1y1y breakeven widened 3bps to 3.50% whereas the 5y5y narrowed 3bps to 3.71%. 

Macro Backdrop

BRAZIL
  • The IPCA increased 0.24% in July, topping our call (0.17%) and the median of market expectations (0.18%). The index fell 0.23% in the previous month and went up 0.52% in July 2016. Year-to-date, the IPCA climbed 1.43%, down significantly from 4.96% in the year-earlier period. The year-over-year change in headline inflation slid to 2.71% (the lowest reading since February 1999) from 3.00% in June. Breaking down by product groups, the largest upward contribution during the month came from housing (0.25 p.p.), driven by electricity bills, which went up 6.0% in July – an impact of 0.20 p.p. on monthly inflation –, following the activation of the yellow mode, tariff adjustments by some utility companies and tax increases. 
  • Our preliminary estimate for the IPCA in August is a 0.50% increase, pushing up the year-over-year change to 2.8% from 2.7% in July. Fuels will give the biggest upward contribution, due to tax hikes for gasoline, ethanol and diesel since July 20. Following the activation of the red mode, electricity bills will also exert upward pressure on August inflation. Full Report
  • Caged formal job creation came in at 35.9k in July, above our estimate (-1k) and market expectations (+5.7k). Seasonally adjusted, 17.4k jobs were created, taking the 3-month moving average to 2k (from -11k) - the first positive reading since November 2014. The strong reading is consistent with a gradual economic recovery and improvement of the job market (including the formal sector). However, historically, stabilization of the unemployment rate without increased informality has required net creation of around 40k formal jobs. 
  • Paper cardboard dispatches (ABPO) rose 1.2% mom/sa in July (our seasonal adjustment), up 2.6% 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 by 0.5 p.p. to 0.3% mom/sa in July. 
  • The reading of the rapporteur’s report in the Congress Commission debating the creation of the TLP (new BNDES benchmark rate) was postponed due to insufficient quorum. According to Bloomberg, Representative Darcísio Perondi said the report will be read on August 15. The provisional measure creating the TLP will expire on September 6. 
MEXICO
  • In July, consumer prices were pressured by the volatile agricultural prices, the food component of core goods, and the seasonality of tourism-related services. The CPI posted a 0.38% monthly variation, surprising our forecast and median market expectations (both 0.32%) to the upside. Agricultural prices spiked by 2.49% month-over-month, adding 24bps to the CPI print. The food component of core goods - which is sensitive to agricultural prices and imported food commodities (such as wheat and soy, whose prices increased significantly) - rose by 0.40% month-over-month. In contrast, the non-food components of core goods fell 0.12% (the largest monthly deflation for this item in more than two years), indicating that MXN appreciation is already exerting downward pressure. Core service prices increased by 0.40% month-over-month, although this was largely due to the seasonality of tourism-related services - such as tourism packages (9.71%), air transport (7.45%), and hotels (1.63%) - which posted sharp price increases. Overall, we note that the gap between the monthly inflation prints and the 5-year median is decreasing. This gap was 10bps in July, down from an average of 39bps in 1H16. Headline inflation increased to 6.44% year-over-year (from 6.31% in June), while core inflation reached 4.94% (from 4.83%) during the same period. 
  • We expect annual inflation to decrease to 5.4% by the end of 2017. The appreciation of the MXN observed so far this year will be the leading driver for disinflation, with a benign impact on core tradable prices and energy prices (especially gasoline). Full Report
  • Supermarket & department store (ANTAD) sales weakened in July, mainly dragged by the fall of real wages and less supportive fundamental variables. ANTAD sales expanded 4% year-over-year in July, closer to our forecast (4.5%) than to median market expectations (5.8%). Thus, the three-month moving average growth rate decreased to 5% year-over-year (from 5.7% year-over-year in June). We highlight that the slowdown is mainly observed in department stores and specialized stores, while supermarkets are performing better. This makes sense considering that the goods sold at supermarkets (mainly food and other first necessity products) probably have a more inelastic demand. Importantly, inflation increased in July (to 6.4%, from 6.3% in June), denting real wages (which have fallen consistently throughout the first six months of 2017). Moreover, consumer credit has begun to slow down more visibly (to 6.7% year-over-year in June (from 10.7% in May), amid higher domestic interest rates; and the growth of remittances converted into pesos has decreased substantially (2% year-over-year in June, from a 28% annual growth in 2016), because of MXN appreciation.
  • We believe the slowdown of consumption will be short-lived. In fact, the real wage bill is already recovering at the margin (3.5% qoq/saar in 2Q17 vs. 0.4% in 1Q17), given that sequential inflation (that is, seasonally-adjusted and annualized) peaked in 1Q17. The decline in inflation we anticipate will support the real wage bill further. Moreover, the moderation of the uncertainty surrounding the Mexican economy – with more clarity on the future course of the Nafta renegotiation and more constructive views from the rating agencies (S&P and Fitch recently revised Mexico’s credit rating outlook to stable, from negative) – will likely curb the slowdown of investment, and thus prevent a large negative impact in the labor market. 
Market Developments 
  • GLOBAL MARKETS: The VIX climbed to 12.33 (Tuesday: 10.96) amid geopolitical concerns in the Pacific region. As markets traded with a risk-off tone, safe haven assets outperformed: JPY (+0.23%), CHF (+1.08%) and gold (+1.30%). Global Markets Tracker
  • CURRENCIES & COMMODITIES: Oil prices rose (WTI: +1.03% to USD 49.86/bbl) as EIA reported a sixth successive decline in US crude inventories last week. In FX, LatAm currencies (-0.65%) posted losses. By the time of writing, the MXN is trading 0.52% weaker to 17.9440/USD. The COP depreciated 0.19% to 3,002/USD and the CLP was stable at 648.14/USD (+0.05%). The BRL was the laggard within high-beta pairs, closing at 3.1557/USD (-0.93%). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads widened all across LatAm. For the 5-year tenor, CDS in Mexico, Brazil and Colombia inched up 2bps to 102bps, 200bps and 126bps, respectively. Country risk in Chile inched up 1bp to 63bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bear steepened in the session. In DI futures, the Jan-19 went up 4bps to 8.06% and the Jan-21 widened 7bps to 9.32%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican rates widened as CPI came in above expected (see Macro Backdrop). In TIIE swaps, the 1-year increased 3bps to 7.36% and the 5-year went up 4bps to 6.95%. The implied inflation term structure flattened: the 1y1y breakeven widened 3bps to 3.50% whereas the 5y5y narrowed 3bps to 3.71%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields narrowed 1-2bps. In Camara swaps, the 1-year inched down 1bp to 2.41% and the 5-year decreased 1bp to 3.37%. Chile Rates Tracker In Colombia, long rates went down. In IBR swaps, the 1-year was stable at 4.99% and the 5-year narrowed 2bps to 5.58%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, traffic of heavy vehicles (ABCR), a coincident indicator for July's industrial production, may be released. Moreover, IBGE will release the monthly update of its Systematic Survey of Agricultural Production (Thu.). 
  • In Mexico, Banxico will announce its policy rate decision (Thu.). We expect the board the leave the reference rate unchanged at 7%, considering the guidance provided in the latest statement, which signaled the end of the tightening cycle (400-bps since December 2015). Finally, the statistics institute (INEGI) will publish June’s industrial production (Fri.). We expect a 0% year-over-year expansion (down from 1% in May), based on coincident indicators – such as vehicle production, oil output, and public investment – which weakened in June. 
  • In Colombia, Banrep will release the minutes of the July monetary policy meeting (Fri.). 
  • In Argentina, the INDEC (the official statistical agency) will publish the National CPI for July (Thu.). According to private estimates, headline inflation likely increased to 2.1% in July mainly due to adjustments in regulated prices, while the core measure hit 1.8%. 

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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