Itaú BBA - LatAm FI Strategy Daily - We now expect Banrep to deliver a 50-bp rate cut next week - May 19, 2017

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LatAm FI Strategy Daily - We now expect Banrep to deliver a 50-bp rate cut next week - May 19, 2017

May 19, 2017

We believe the increased concern with activity will likely lead a majority of the board to favor a second consecutive 50-bp rate cut to 6.00%.

With information available until 6:30pm Brasilia time

Highlights

  • We believe the increased concern with activity will likely lead a majority of the board to favor a second consecutive 50-bp rate cut to 6.00%. IBR swaps narrowed 4-6bps in the session as the disappointing supply-side activity data for 1Q17 (see Macro Backdrop) came in below Banrep’s forecasts. In IBR Swaps, the 18-month went down 5bps to 5.19% and the 5-year fell 6bps to 5.35%. 
  • In Chile, short yields narrowed after BCCh’s 25-bp rate cut Thursday (see Macro Backdrop), which surprised part of the market. In Camara swaps, the 6-month fell 4bps to 2.50% while long rates widened (5-year: +2bps to 3.49%). 
  • Andean FX strengthened (COP: +1.43% to 2,885.21/USD; CLP: +0.89% to 669.23/USD) in tandem with commodity-linked peers (+1.70%). By the time of writing, the MXN is trading 0.59% higher to 18.73/USD. The BRL recovered some of Thursday’s losses, closing at 3.2543/USD (+3.73%). 
  • We publish our Monthly FI Strategy Report. Overcrowding in Brazilian fixed income markets exacerbated the impact of the recent news, as major players were anticipating a rally would occur if the pension reform was approved in the House of Representatives in the short term.

Macro Backdrop

BRAZIL
  • According to CNI, the confidence in the industrial sector reached 53.7 points in May, rising 0.6% mom/sa using our seasonal adjustment (up for the fifth consecutive month). The index is already above the level seen as neutral (50-51), highlighting a gradual improvement in business sentiment. Coming out on May 22 (Monday), we forecast a 0.3% increase for FGV’s industrial confidence in May (preview). The chart shows that the recovery in the FGV index (stronger correlation with industrial output) has been slower than the recovery shown by the CNI index. It is worth mentioning that the May business surveys were probably collected before the recent political developments, hence we may need to wait for the June surveys to measure the impact on sentiment. 
  • In the roll over auction, the BCB placed the full offering of 8,000 FX swaps announced on Thursday (May 18). After closing, the central bank called for a roll over auction of up to 8,000 contracts on May 22. 
  • In the first extraordinary auction, the central bank placed 14,500 contracts (USD 725 million) due in August 2017. For the October 2017, were placed 9,300 contracts (USD 465 million). For the January 2018, were sold 16,200 contracts (USD 810 million). After closing, the BCB confirmed another USD 2 billion FX swap auction on May 22. According to the note published on Thursday, there will be a third auction of the same size on May 23. 
CHILE
  • The Central Bank of Chile surprised most in the market by cutting the policy rate by 25bps for a second consecutive month to 2.5%. The cut came earlier than we were expecting - we believed the cut would only be implemented next month - and for nearly two-thirds of the market, according to Bloomberg as well as the majority in both central bank surveys prior to the meeting. Nevertheless, the lowering of the policy rate is in accordance with our call from late last year of a 100bp easing cycle from the 3.5% starting point. In line with the view that the current cycle has ended (at least in short-term) is the removal of the easing bias in the press release communicating the decision. Hence, it is unlikely that the upcoming Inflation Report forecast scenario includes guidance towards lower rates.
  • Our baseline scenario considers no further easing, while the start of a normalization process is likely by yearend 2018 as internal demand recuperates. However, activity is weak and the composition of the 1Q17 growth (0.1% year over year) hints that the risk of further weakening ahead is not negligible. If this scenario materializes, additional rate cuts later in the year are a possibility. Full Report
COLOMBIA
  • Activity started 2017 on a weak note after posting the lowest growth rate since 4Q08. The impact of the 2014 terms-of-trade shock continues to unfold, with historically high interest rates, high inflation and increased tax rates dampening activity’s performance. Activity gained a mild 1.1% year-over-year in 1Q17, down from the 1.6% recorded in 4Q16. This came in line with market consensus, but below our 1.4% forecast. Activity grew 1.6% for the rolling-4Q period, down from 2.0% in 2016 and 3.1% in 2015. At the margin, activity fell at the fastest pace since 3Q12. The GDP declined 0.9% qoq/saar, from +4.1% in 4Q16. The slowdown was led by the construction sector (-9.9% vs. -2.7% in 4Q16), commercial activities (-8.3% vs. +4.7% in 4Q16). Meanwhile, social services, heavily influenced by government expenditure, grew at a higher rate (+5.8% qoq/saar, compared to 2.4% previously). Activity in non-natural resources continued to lead activity in the quarter, but it is showing signs of weakening. Activity increased 1.4% year over year (2.2% in 4Q16), and a lower 1.2% when oil refining is excluded. Meanwhile, natural resource related activity continued to decline but at a lower rate. Consolidating on the end of the El Niño weather phenomenon, the agriculture sector continued its recovery with growth of 7.7% (+1.9% in 4Q16; +0.5% in 2016), boosted by a coffee production revival. Overall, activity in the natural resource sectors dropped 1.4% year over year in 1Q17 (-3.5% previously). 
  • Activity in Colombia continues to underwhelm. We expect growth of 1.8%, down from 2.0% in 2016, but acknowledge that there is a growing risk that activity disappoints further. Continued low oil investment, a loosening labor market, historically low private sentiment and a still-tight monetary policy will curb growth this year. Yet, we see some recovery in 2H16 and into next year aided by the ongoing monetary-easing cycle and the increased investment related to the 4G PPP program and higher average oil prices. Full Report
  • We now expect Banrep to deliver a 50-bp rate cut to 6.00% at its Friday (May 26) monetary policy meeting. Last month, a split board surprised the majority of the market by cutting the policy rate by 50bps, to 6.50%. The disappointing activity and increased risk of an excessive slowdown supported the move. Following the meeting, central bank governor Juan José Echavarría presented the quarterly inflation report, where he confirmed the balance of risks is tilted towards excessively weak activity. Since the last decision, core inflation remained sticky and inflation expectations ticked up, while activity showed signs of further deterioration, with growth in 1Q17 being the lowest since the global financial crisis and coming in below the central bank forecast. In all, we believe the increased concern with activity will likely lead a majority of the board to favor a second consecutive 50bp rate cut to 6.00%. 
Market Developments 
  • GLOBAL MARKETS: On a weak dollar day (DXY: -0.78%), equity markets were strong on the green and volatility gauges receded. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities posted solid gains in the session. Ahead of the Opec meeting next week, oil prices went up (WTI: +2.39% to USD 50.53/bbl). Metal prices have also strengthened (copper: +2.25%; iron ore: +3.40%). In FX, commodity-linked (commodity FX: +1.70%) currencies strengthened across the board. Hence, all currencies under our coverage appreciated. The MXN is trading 0.59% higher to 18.73/USD. The COP strengthened 1.43% to 2,885.21/USD and the CLP posted gains of 0.89% to 669.23/USD. The BRL recovered some of Thursday’s losses, closing at 3.2543/USD (+3.73%). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads for the 5-year tenor were narrowed all across LatAm. Mexican spreads decreased 6bps to 114bps while Chilean spreads went down to 72bps (-2bps). CDS in Colombia decreased 6bps to 127bps. Country risk in Brazil went down the most, giving back some of Thursday losses, to 247bps (-19bps). External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: DI futures edged lower as the Treasury’s extraordinary buyback auctions seemed to have helped the market find its footing. The Jan-19 narrowed 42bps to 9.99%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve bear flattened on a correction to Banrep’s 25-bp rate hike on Thursday. In TIIE swaps, the 1-year increased 8bps to 7.45% and the 5-year went up 2bps to 7.28%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, short yields narrowed after BCCh’s 25-bp rate cut Thursday (see Macro Backdrop), which surprised part of the market. In Camara swaps, the 6-month fell 4bps to 2.50% while long rates widened (5-year: +2bps to 3.49%). Chile Rates Tracker In Colombia, rates narrowed 4-6bps in the session as the disappointing supply-side activity data for 1Q17 (see Macro Backdrop) came in below Banrep’s forecasts. In IBR Swaps, the 18-month went down 5bps to 5.19% and the 5-year fell 6bps to 5.35%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, May’s IPCA-15 consumer inflation preview will be released (Tue.). We forecast a 0.20% monthly rise, with year-over-year inflation slowing to 3.7% (from 4.4%). The main risks for inflation are of political nature, especially on matters that would interfere with the Social Security reform process in Congress. On fiscal accounts, April’s tax collection will be released throughout the week. We forecast BRL 114.6 billion in tax collections, or a decline of 0.7% year-over-year in real terms. Then, the consolidated primary budget balance for April will come through (Fri.). We expect a BRL 9.0 billion surplus, with the central government result (due Thur.) posting a BRL 8.2  billion surplus and regional governments and state-owned companies’ result amounting to a BRL 2.0 billion surplus (they don’t add up due to a discrepancy between the Treasury’s and the Central Bank’s expenditure accounting). Onto the balance of payments report (Tue.), we expect a current account surplus of USD 950 million in April, topping last year’s surplus of USD 411 million for the same month. Over twelve months, the current account deficit should sum to USD 20 billion (-1.1% of GDP). We expect direct investment in the country (DIC) to register inflows of USD 5.5 billion in April - if confirmed, DIC will amount to USD 85 billion over 12 months. Finally, in economic activity, FGV’s industrial business confidence preview for May will be released (Mon.), for which we expect another increase in seasonally adjusted terms (0.3%). Also to be released are confidence indicators (FGV) for consumers (Wed.), retail (Thu.) and construction (Fri.). 
  • In Mexico, the statistics institute (INEGI) will publish Q1’s GDP growth (Mon.). We expect a 2.7% year-over-year growth (up from 2.4% in 4Q16) in line with the flash estimate. Along with the quarterly GDP data, INEGI will also publish March’s monthly GDP proxy (IGAE), which we forecast at 4.1% year-over-year (after growing 1% in February). Then, INEGI will announce March’s retail sales (Tue.). We estimate that retail sales picked up to 5% year-over-year, after growing 3.6% year-over-year in February. Moreover, INEGI will publish CPI inflation figures for the first half of May (Wed.). We expect bi-weekly inflation to post -0.42%, explained by the decrease of electricity tariffs announced by the Federal Electricity Commission (CFE), a decrease of gasoline prices, and a drop of agricultural prices (which spiked in April). Assuming our forecast is correct, headline inflation would increase to 6.08% year-over-year (from 6.01% in the second half of April). Following, INEGI will announce April’s trade balance (Thu.), which we expect to come in at USD -1,500 million. We expect the trade deficit to continue narrowing at the margin, driven by an improvement in the non-energy balance which is explained by firmer manufacturing exports (boosted by stronger industrial output in the U.S. and a competitive real exchange rate). Shortly after, the Central Bank will publish Q1’s current account balance (Thu.). We expect the current account deficit at USD 6,795 million in 1Q17, with the 4-quarter rolling deficit narrowing to USD 25.8 billion (2.5% of GDP, according to our calculations) from USD 27.9 billion (2.7% of GDP) in 4Q16. Finally, INEGI will announce April’s unemployment rate (Fri.). We expect the unemployment rate to post 3.3% (below the 3.8% rate recorded in the same month of last year) given that labor market conditions remain tight. 
  • In Colombia, local think-tank Fedesarrollo will publish the April industrial and retail confidence indicators (Wed.). With the economy continuing to show signs of weakness, we expect confidence levels to remain at low levels. Then, the central bank hosts its monthly monetary policy meeting (Fri.). Last month, a split board surprised the majority of the market by cutting the policy rate by 50bps to 6.50%. We believe that the increased concern with activity will likely lead a majority of the board to favor a second consecutive 50-bp cut to 6.00%.

Latam Macro Calendar

Today's editors: Eduardo Marza, Pedro Correa



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