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Labor reform clears the Brazilian Congress

July 12, 2017

In Brazil, country risk fell substantially (-7bps to 229bps) after the labor reform was approved in the Senate.

With information available until 6:30pm Brasilia time


  • In Brazil, country risk fell substantially (-7bps to 229bps) after the labor reform was approved in the Senate. In rates, the DI futures curve bull flattened (Jan18x21: -15bps) pressured also by weaker retail sales (see Macro Backdrop). The BRL (+1.44% to 3.2084/USD) outperformed within LatAm on reduced market concerns regarding the 2018 elections. 
  • Elsewhere, LatAm FX posted gains after Fed Yellen’s speech in the Semiannual Report to the Congress. She signaled gradual rate hikes, but put more emphasis on inflation uncertainty. The MXN is trading 0.75% stronger to 17.78/USD. The CLP appreciated 0.49% to 663.19/USD and the COP posted gains of 0.78% to 3,049.92/USD. 

Macro Backdrop

  • Retail sales decline slightly in May. Core retail sales dropped 0.1% mom/sa in May, below the median of market estimates (0.3%) and in line with our forecast. Compared to May 2016, core sales expanded 2.4%, marking a second consecutive gain after 24 months in negative territory. Broad retail sales declined 0.7% mom/sa, also below the median of market estimates (0.2%) and in line with our call (-0.9%). Compared to May 2016, broad retail sales climbed 4.5%. The breakdown by component paints a rosier picture, with monthly sales gains for vehicles (1.2%), supermarkets (1.4%) and construction material (1.9%). At 60%, diffusion across sectors is consistent with the increase in the aggregate index. Coincident indicators (retail activity indexes, vehicle sales, surveys with consumers and commerce entrepreneurs) suggest that broad retail sales expanded 1.3% mom/sa in June, while core retail sales were flat. Full Report
  • Our monthly GDP proxy (PIBIU) dropped 1.6% mom/sa in May. Compared to one year earlier, monthly GDP slid again, by 0.6%. In the quarter ended in May, the indicator also fell, by 0.8% vs. 1Q17. These figures suggest a contraction in economic activity in 2Q17. Five out of ten PIBIU components posted seasonally-adjusted monthly declines, with agriculture suffering the sharpest drop (-1.5%). On the other hand, construction indicator had the biggest gain (1.5%). Preliminary figures for June suggest stability in PIBIU during the month. Full Report
  • The Senate approved the labor reform text by 50 votes in favor and 26 against on Tuesday (July 11). The amendments were rejected, so now the bill moves on to presidential approval. 
  • 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 13. 
  • Industrial production remains subdued, as the pick-up of manufacturing is offset by the sharp fall of mining output (mostly oil & gas) and the weakening of the construction sector. Industrial production expanded 1% year-over-year in May, above our forecast (0.1%) and median market expectations (0.3%), lifting the three-month moving average growth rate a bit (to nil, from -1% year-over-year in April). At the margin, seasonally-adjusted industrial production gained a modest 0.1% from the previous month, with the quarter-over-quarter annualized growth rate falling to -0.9% (from -0.7% qoq/saar in April). 
  • We expect weak industrial production growth throughout 2017. The fiscal consolidation is not only hitting oil output - as PEMEX has been forced to slash its capital expenditures - but also construction investment. Moreover, the uncertainty over trade relations with the US is putting investment decisions on hold, posing another significant headwind on the construction sector. On the positive side, manufacturing output will continue to be boosted by stronger growth in the US economy. Nevertheless, we note that the cost advantage benefitting Mexican manufacturers, with the real exchange rate at very competitive levels, has narrowed substantially in 2017 (considering that the MXN has appreciated 14%, reaching 17.8/USD as of mid-July). Full Report
  • Thursday, the BCCh holds its monthly monetary policy meeting at which we expect the board to stay put. The central bank implemented an easing cycle totaling 100bps in the first five months of this year, taking the policy rate to 2.5%. In the Inflation Report released last month, the central bank’s baseline scenario considered rates on hold for a prolonged period. According to the July central bank’s analyst and trader survey, no rate move is expected this month. While the median of analysts do not see further easing, the survey showed a pickup in the percentage of respondents who see the need for additional easing ahead. Meanwhile, the median of traders also see the central bank on hold this month, but now see one additional 25bp rate cut within the next three months. These changes most likely arose following the large downside inflation surprise in June (-0.4% MoM vs. the 0% Bloomberg market consensus). Asset prices show there is no expectation of a rate cut this month (although a further cut is priced in before yearend). At this meeting, we believe the central bank will refrain from a knee-jerk reaction to the June inflation print and rather wait to see the evolution of activity and inflation ahead. Inflation expectations for the relevant 2-year horizon are still around the 3% target (analysts: 3%; traders: 2.8%). We see the policy rate stable at 2.5% this year; however, we acknowledge there are risks of further interest rate cuts.
  • Credit demand showed diverging behavior between consumers and firms. Demand for consumer credit and mortgages expanded in 2Q17, but remain weak overall, while supply is still tight, according to the Central Bank’s quarterly survey of credit conditions. On balance, entities saw signs of increasing demand for consumer loans in the second quarter (+7 p.p. from -21 p.p. in 1Q17; index centered at 0). Nevertheless, within the respondents that saw weaker demand, there was a move from moderate weakening to significant weakening, signaling that the headline improvement is not widespread. Meanwhile, demand for mortgages also showed an expansion (8 p.p.; from balanced in 1Q17). On the other hand, there is reduced demand from real estate and construction companies (to -52 p.p. from -46 p.p. in 1Q17) as well as from SMEs (to -15 p.p. from -7 p.p.). Weaker demand from large business moderated to -7 p.p. (from -31 p.p. in the previous quarter). On the supply side, all segments continue to show more restrictive conditions, with a particular tightening in the companies and mortgage segments versus 1Q17. Weak dynamism in the demand for loans as well as tightening lending conditions can partly explain the persistent weakness in the Chilean economy.
Market Developments 
  • GLOBAL MARKETS: US treasuries narrowed (5-year: -4bps to 1.87%) and equity markets were on the green after Fed Chair Yellen’s speech in the Congress. In the statement, she said “there is, for example, uncertainty about when – and how much – inflation will respond to tightening resource utilization”. The Fed funds futures implied probability of another hike this year fell to 42% from 49% as of Tuesday. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities traded lower pressured mostly by oil and grains. Oil prices were hit (WTI: +0.87% to USD 45.43/bbl) after the DOE report showed oil production rose again, to the highest level since July 2015. Moreover, soybeans fell 0.89% after USDA’s crop revision. Global stockpiles for the 2017/2018 crop were adjusted upwards by 1.3 million tons. EM FX (+0.64%) posted gains after Yellen’s speech. In LatAm FX (+1.07%), the MXN is trading 0.75% stronger to 17.78/USD. The CLP appreciated x% to 666.44/USD and the COP posted gains of 0.04% to 3.2545/USD. The BRL outperformed (+1.44% to 3.2084/USD) on reduced market concerns regarding the 2018 elections. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads narrowed all across LatAm. For the 5-year tenor, CDS in Chile fell 1bp to 65bps. Mexican spreads went down 2bps to 11bps and in Colombia they went to 138bps (-3bps). In Brazil, country risk fell the most in the session after the labor reform was approved in the Senate (-7bps to 229bps). External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bull flattened (Jan18x21: -15bps) on the back of a stronger BRL and weaker retail sales figures (see Macro Backdrop). In DI futures, the Jan-19 fell 9bps to 8.64% and the Jan-25 went down 22bps to 10.47%. Likewise, real rates fell substantially: May-21 went down 12bps to 5.25%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Long Mexican yields narrowed, tracking US treasuries. In TIIE swaps, while short rates inched down (9-moth: -1bp to 7.38%), long ones fell more as the 10-year went down 5bps to 7.11%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, short rates went up while long ones traded lower at the margin. In Camara swaps, the 1-year widened 3bps to 2.35% and the 5-year fell 2bps to 3.32%. Chile Rates Tracker In Colombia, yields were mixed in the session, as the 1-year IBR swap stood flat at 5.03% and the 5-year narrowed 4bps to 5.49%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, activity releases will be on the spotlight. The Service Sector Survey (PMS)  will be released (Thu.). 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.). 
  • 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.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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