Itaú BBA - LatAm FI Strategy Daily - The MXN closes the week on a positive note - April 28, 2017

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LatAm FI Strategy Daily - The MXN closes the week on a positive note - April 28, 2017

April 28, 2017

The MXN ended a volatile week on a high note, buoyed by Moody’s decision to affirm Mexico’s rating and better headlines about North American trade relations.

With information available until 6:30pm Brasilia time


  • In LatAm FX, currencies under our coverage were mixed. Andean currencies depreciated as the COP posted losses of 0.19% to 2,943.00/USD and the CLP weakened 0.52% to 667.35/USD. On the other hand, the BRL appreciated 0.25% to 3.1768/USD. Finally, the MXN ended a volatile week on a high note, buoyed by Moody’s decision to affirm Mexico’s A3 rating and better headlines about US, Canada and Mexico trade relations (+1.10% to 18.82/USD).
  • Brazilian yields erased some of the weekly losses amid ongoing government efforts to cement support in the Lower House for the pension reform. In DI futures, the Jan-18 went down 2bps to 9.49% and the Jan-21 narrowed 8bps to 10.01%. 

Macro Backdrop

  • Business confidence in the industrial sector (FGV) rose 0.6% mom s.a. in April, slightly above the preview (0.1%). The breakdown shows another improvement in expectations (1.4%) and a small decline in the current situation index (-0.2%) after a strong figure in the previous month (2.4%). Also, capacity utilization rose 0.3 p.p. (preview: flat), suggesting a slow rebound from mid-2016 levels. Inventories (% excessive minus insufficient) fell slightly to 6.7% from 6.8% in the previous month. Actual industrial demand fell 1.8% and expected demand fell 1.2% (following a 7.4% increase in March). Twelve out of twenty activities showed an increase (diffusion: 60%), consistent with a better aggregate result for confidence. Going forward, we expect the industrial confidence to increase further and drive an increase in capacity utilization (and industrial production).Business Confidence Heatmap
  • Service Sector Confidence (FGV) shrank 1.3% mom s.a. in April, driven by a fall in expectations (4.5%). Nonetheless, current situation index advanced 3% mom s.a. The decline comes after a steep increase in the previous month (+5.4% mom s.a.).
  • The nation-wide unemployment rate reached 13.7% in March, slightly above our estimate (13.5%) and in line with market consensus. The indicator increased 2.8 p.p. from 10.9% one year ago. Applying our seasonal adjustment, the unemployment rate rose to 13.2% in March from 13.1% in February. The labor force expanded 0.1% mom s.a. and 1.4% yoy. Employment fell 0.1% during the month and is 1.9% lower than in March 2016. Formal jobs in the private sector (-0.5% mom/sa) were behind the decline in overall employment. The seasonally-adjusted participation rate (ratio of the labor force to the working-age population) increased 0.1 p.p. to 61.6% and remains slightly above its historical average (61.3%). All in all, PNAD Contínua continues to show an increase in unemployment, with the rate climbing to 13.2% from 13.1% (using our seasonal adjustment), marking the 28th consecutive advance. We expect unemployment to continue its upward trend, as the drop in economic activity has not yet been fully reflected in the labor market. Full Report
  • The consolidated public sector posted a primary deficit of BRL 11 billion in March, slightly narrower than our forecast (BRL -11.8 billion) and market consensus (BRL -11.5 billion). The consolidated primary deficit accumulated over 12 months remained at 2.3% of GDP. The central government had a deficit of BRL 11.1 billion in March under the National Treasury’s methodology, which was wider than our estimate (BRL -8.8 billion) and market expectations (BRL -8.8 billion). Over 12 months, the central government’s primary deficit remained at 2.4% of GDP. Year-to-date, the result remains close to levels seen one year ago. The biggest deviation from our call came from higher expenses (by BRL 2 billion). The surprise was caused mostly by larger outlays involving bonuses paid to low-wage workers and unemployment aid and, to a lesser extent, by personnel and discretionary spending. The disappointment does not change our expectation that the central government will meet its target for the primary deficit this year, of BRL 139 billion. Extraordinary revenues, roll-backs of tax exemptions and lower discretionary expenses will help the central government to start a gradual reversal in public accounts.
  • Public debt dynamics remains unfavorable. The general government’s gross debt edged up to 71.6% of GDP in March from 70.6% in February, while net debt advanced to 47.8% of GDP from 47.4%. If approved, the pension reform will be essential for the reversal of public debt dynamics. In addition to reversing the current upward trend in pension expenses and being a key step to comply with the constitutional spending cap amendment, it may generate the necessary conditions for the structural decline in interest rates and the rebound in economic activity. Full Report
  • The flash estimate of GDP growth was stronger than expected in 1Q17. Growth for 1Q17 came in at 2.7% year-over-year, above market expectations (2.5%). Adjusting for calendar effects, growth was a bit lower (2.5% year-over-year), about the same as in 4Q16. A negative leap-year effect in February was offset by a positive calendar effect in March (due to Easter holidays taking place in April). At the margin, GDP expanded 0.6% from the previous quarter, with quarter-over-quarter annualized growth slowing down to 2.4% (4Q16: 2.9%). The breakdown by sectors shows that industrial growth is anemic (in spite of stronger manufacturing) and that services activity remains robust. Industrial growth was nil at the margin. Stronger manufacturing, as shown in February’s industrial data and March’s trade balance figures, is falling short to offset the sharp contraction of oil & gas output and weaker construction. Services, in contrast, advanced 4.1% qoq/saar from the previous quarter. The volatile primary sectors (mostly agriculture) rebounded in 1Q17 (2.8% qoq/saar, previous: -1.4%) contributing positively to GDP growth. 
  • Our take from the flash estimate is that Mexico’s activity is showing resilience to the shocks. The bearish sentiment triggered by the result of the U.S. presidential elections and the spike of inflation in January (caused by gasoline price liberalization and the MXN sell-off) haven’t had a material impact in GDP figures yet. We recently revised up our GDP growth forecast for 2017 (to 1.8%, from 1.6%) but still expect a slowdown from last year’s annual growth (2.3%). In our view, domestic demand will likely slow down. Tighter macro policies (both fiscal and monetary), higher inflation (eroding consumer spending), and the uncertainty over trade protectionism in the U.S. (affecting investment decisions in Mexico) will have a negative effect. Conversely, stronger manufacturing exports - boosted by firmer U.S. activity a competitive real exchange rate - will act as a buffer.Full Report
  • The industrial production index fell 8.3% year over year in March, the same as the downwardly revised rate for February, pulled down by the 21.4% fall in mining production (-16% in February). This is the largest annual mining contraction since the start of the series in 1991. Utilities also contracted 1.2% in the month, hampered by diminishing electricity production. Meanwhile, manufacturing grew 1.9% year over year (-2.7% previously), a positive surprise compared to market consensus and our forecast of -1.5%. This gain was principally due to the 14.2% year over year increase in food processing (+4.6 percentage points to the total gain). Overall, the weakness of manufacturing is still evident with 65% of the categories shrinking (compared to 40% one year ago). Meanwhile once the seasonal and calendar effects are excluded, manufacturing dropped 0.7% (as was the case in February). In 1Q17, industrial production fell 6.0% (-2.0% in 4Q16), hindered by the 13.4% drop in mining (-3.5% in 4Q16). Manufacturing fell 0.6% (-2.0% in 4Q16) and utilities growth fell to 0.2% from 4.3% in 4Q16. At the margin, industrial activity worsened. Industrial production fell 7.3% qoq/saar (-4.9% in 4Q16), dragged down by the 30.5% qoq/saar decline in mining (-4.4% in 4Q16). Manufacturing showed some improvement to +2.1% qoq/saar (-3.1% in 4Q16). 
  • The still low private sentiment, partly due to uncertainty in the lead up to the November presidential election, a weakening labor market and the adverse impact of supply-side shocks put a downside bias to our 1.8% growth forecast this year (1.6% in 2016). After a weak beginning to the year, higher copper prices relative to 2016, low inflation and falling interest rates will provide some support for growth. With partial information (private consumption activity to be released on May 3), we preliminarily expect the GDP proxy (IMACEC) to have contracted 1% year-over-year in March (-1.3% previously), leading to an annual contraction of GDP in 1Q17 (+0.5% in 4Q16). Full Report
  • The unemployment rate continued to rise in the first quarter of 2017. Compared to the final quarter of 2016, employment growth has picked up but is mainly due to creation of low quality jobs. The unemployment rate came in at 6.6% in the quarter, up 0.3 percentage points from one year before, and in line with ours and market expectations. Total job growth pickup up to 1.4%, up from the 1% in 4Q16. Meanwhile, the labor force growth increased to 1.8% from 1.3% in 4Q16. The employment gains are led by the 6.6% year over year increase in self-employment (4.6% in 4Q16). Meanwhile, salaried employment contracted 0.4% from one year earlier, in spite of a low base of comparison, worsening from the 0.1% drop in 4Q16. Additionally, of the net jobs created, those that lack contracts increased by 7.6% in the quarter (4.6% in 4Q16), also reflective of the job growth weakness. We expect the labor market to remain weak in the months ahead as there is no clear catalyst to inspire an economic turnaround. We expect the unemployment rate to average 7.0% this year (from 6.5% in 2016). Full Report
  • Labor market data for 1Q17 showed mixed signals with loosening in the urban areas being partly countered by the recovery in rural agricultural employment following the end of El Niño. The national unemployment rate for 1Q17 came in at 10.6%, down from the 10.7% recorded one year earlier, meanwhile the urban unemployment rate ticked up 0.2 percentage points to 11.7%. However, once corrected for seasonal factors, both measures increased from 4Q16. In turn, the labor market participation dropped 0.8 percentage points in urban areas over the last 12-months reaffirming the weakening of the labor market (national participation dropped 0.3 points). National employment growth picked up to 0.9% year over year in 1Q17 (0.4% in 4Q16). Of the 202 thousand jobs created nationally, manufacturing contributed 123 thousand while agriculture added 89 thousand. We expect the labor market to loosen in upcoming months. Recent activity indicators signal slowing activity economy that could deteriorate job quality even further and maintain a low rate of job creation. Full Report
  • In another split decision, Banrep cut the policy rate by 50 bps, to 6.50%. Out of the six voting members, two co-directors opted for a 25-bp cut. This was the sixth consecutive divided board, with the decision surprising two-thirds of Bloomberg’s respondents, as well as us, who expected a 25bp rate cut. The press release announcing the decision highlights the disappointing activity in 1Q17 (industrial production, retail sales and consumer confidence), leading the technical staff to lower its 2017 growth forecast to 1.8%, from 2% previously (2% in 2016). Despite the measurement error regarding the output gap, the board considered the risk that excess capacity widens has increased. Meanwhile, inflation is evolving in line with expectations, led by the dilution of previous supply-side shocks. In fact, the central bank’s medium-term inflation forecast has declined amid the recent disinflation. At the same time, falling inflation expectations have resulted in an even more contractionary real policy rate. Nevertheless, the board does note that indexation mechanisms and the increased stickiness of some prices (as reflected by non-tradable inflation) could delay the convergence of inflation to the 3% target. The latter comment likely means this is not a permanent shift in the velocity of the expected loosening cycle. We expect the central bank to continue lowering the policy rate, but the pace of rate cuts will be data-dependent. We see the policy rate ending the year at 5.5% (7.50% in 2016). Full Report
Market Developments 
  • GLOBAL MARKETS: Long Treasuries narrowed as US 1Q17 GDP came in weaker-than-expected. For the 10-year, rates fell 2bps to 2.28%. The Fed Funds futures implied probability of a hike in June went down to 57% from 61% as of Thursday. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities traded higher as oil prices increased (WTI: +0.39% to USD 49.16/bbl) and metals posted gains (iron ore: +2.94%). In LatAm FX, currencies under our coverage were mixed. Andean currencies depreciated as the COP posted losses of 0.19% to 2,943.00/USD and the CLP weakened 0.52% to 667.35/USD. On the other hand, the BRL appreciated 0.25% to 3.1768/USD. Finally, the MXN ended a volatile week on a high note, buoyed by Moody’s decision to affirm Mexico’s A3 rating and better headlines about US, Canada and Mexico trade relations (+1.10% to 18.82/USD). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads for the 5-year tenor widened all across LatAm. CDS in Chile inched down 1bp to 72bps. Country risk in Brazil fell 2bps to 218bps. Mexican and Colombian spreads went down 3bps to 119bps and 126bps, respectively. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian yields erased some of the weekly losses amid ongoing government efforts to cement support in the Lower House for the pension reform. In DI futures, the Jan-18 went down 2bps to 9.49% and the Jan-21 narrowed 8bps to 10.01%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve bull flattened in the session. In TIIE swaps, the 1-year decreased 3bps to 7.24% and the 15-year went down 7bps to 7.68%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, rates traded range bound. In Camara swaps, while the 1-year stood flat at 2.48%, the 7-year inched up 1bp to 3.75%. Chile Rates Tracker In Colombia, short rates fell and long widened. In IBR Swaps, the 1-year fell 1bp to 5.49% and the 8-year widened 2bps to 5.58%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, in a week shortened by a holiday on Monday, markets will remain focused on the social security reform discussions in Congress. It is possible that the Lower House Special Commission votes the reform, but it could also be postponed to the week starting on May 8th. Then, March industrial production will be the main highlight on economic activity (Wed.). We expect a 0.7% seasonally-adjusted drop. Additionally, both Anfavea (Friday) and Fenabrave (date undefined) will release data from the automobile sector in April, which helps to estimate industrial production and retail sales for that month. Moreover, on the external sector, we expect continuous improvement in the trade balance (Tue.). We forecast a surplus of USD 7.0 billion in April, topping the USD 4.9 billion surplus in the same month last year.
  • In Mexico, the Central Bank will publish April’s Economist Survey (Tue). We believe that inflation expectations for the short term might increase a bit, considering the most recent inflation data. On GDP growth expectations, forecasts could be revised up, as the economy has performed better-than-expected in 1Q17. Then, the statistics institute (INEGI) will publish February’s gross fixed investment (Thu.). We forecast that gross fixed investment grew 0.1% year-over-year (up from a 0.5% contraction in January).
  • In Chile, the national statistics agency (INE) will publish the private consumption activity indicators for March (Wed.). We expect the commercial activity index to have increased 1.0% from last year. Then, the central bank will publish the minutes from the April monetary policy meeting (Tue.). It will be key to see if the decision to cut rates received the full backing of the board, whether there is widespread appetite for additional easing and what economic conditions would trigger additional rate cuts. Moreover, central bank will publish the GDP proxy (Imacec) for the month of March (Fri.). We expect the GDP proxy to decline 0.9% from February (-0.7% in the previous month), resulting in an annual growth rate fall of 1.0% (-1.3% in the previous month), concluding the weakest quarterly activity since the global financial crisis.  Finally, the National Institute of Statistics (INE) will publish nominal wage growth for March (Fri.). Wage inflation has continued to moderate as the labor market loosens, the economy cools and inertia stays low (as inflation is running below the target). 
  • In Colombia, DANE will publish export data for March (Wed.). We expect to see exports of USD 3.1 billion (USD 2.3 billion one year ago). Then, inflation for April will be released (Fri.). We expect consumer prices to gain 0.37% from March, taking annual inflation down to 4.55%, with core prices (inflation excluding food and energy) remaining sticky. 

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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