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LatAm FX strengthen as soft inflation reinforces a gradual Fed

May 12, 2017

Treasuries narrowed as US core CPI indicates another soft core PCE print in April.

With information available until 6:30pm Brasilia time


  • Treasuries narrowed as US core CPI indicates another soft core PCE print in April. As 2Q17 GDP rebound is on track, we expect the Fed to hike in June, but a gradual pace was reinforced by weaker core inflation trends. One additional rate hike in 2017 (September), after the one in June, remains likely, but risks look more balanced in the near term. 
  • On a weak dollar day, all currencies under our coverage appreciated. The MXN is trading 0.09% higher to 18.82/USD. The CLP posted mild gains to 671.35/USD (+0.10%). The COP strengthened 0.35% to 2,918.33/USD. The BRL appreciated 0.56% closing at 3.1224/USD.

Macro Backdrop

  • According to the IBGE monthly services survey (PMS), services sector real revenue fell 2.3% mom s.a. in March, following four months of alternating stability with small increases. The growth came at -5.0% yoy, below the median of expectations (-4.0%) and the figure used in our GDP tracking (-4.6%). The weak headline is consistent with industrial production, retail sales and other monthly indicators showing a widespread weakness in March. After a string of data consistent with a pickup in activity between December and February, weak March figures cast doubt on the strength of a rebound. The breakdown by component shows negative figures in all the five major sectors. Finally, the result should impact 1Q17 GDP tracking in -0.1 or -0.2 percentage points.
  • We published our scenario review for the month of May. After a string of data consistent with a pickup in activity between December and February, weak March figures cast doubt on the strength of a rebound. However, consumption is showing signs of improvement. Hence, we maintain our forecasts for GDP growth of 1.0% of GDP in 2017 and 4.0% in 2018, with the weakness in recent data offsetting the stronger pace in 1Q17. In exchange rate, we have revised our YE17 BRL forecast to 3.25/USD (from 3.35/USD). Finally, our estimates for the IPCA consumer price index remain at 3.9% for 2017 and 3.8% for 2018. Full Report
  • Industrial activity began the year on a soft patch, with virtually nil growth in 1Q17. Industrial production expanded by 3.4% year-over-year in March, above our forecast (1%) and market expectations (2.2%), favored by a positive calendar effect; that is, more working days, relative to March 2016, because the Easter holidays took place in April this year. In fact, adjusting for working days, growth was 0% year-over-year. Moreover, using the same data, industrial production contracted 0.1% year-over-year in 1Q17 (from nil growth in 4Q16). At the margin (seasonally-adjusted), growth was 0.1% from the previous quarter, and quarter-over-quarter annualized growth decreased to 0.2% (4Q16: 0.7% qoq/saar). Using working-days adjusted data, manufacturing growth picked up to 3.4% year-over-year in 1Q17 (4Q16: 2.1%), keeping up the solid momentum observed over the past quarters (around 4% qoq/saar). In contrast, construction growth showed a meaningful deterioration in 1Q17 (to 0.5% year-over-year; previous: 3%), posting a quarter-over-quarter annualized contraction (-1.9% qoq/saar, previous: 6%), which we believe reflects the weakening of investment. Meanwhile, mining activity fell 9.8% year-over-year, about the same as in 4Q16, and its momentum remained in negative territory (-4.9% qoq/saar, from -10.7% in 4Q16). Falling oil output is the main drag on mining activity.
  • We expect stronger manufacturing to lift industrial production in 2017, but there are downside risks. Oil output will likely continue to fall in the short-term, as PEMEX has slashed its capex and it will take time for the energy reform to bear fruits. On the construction side, the uncertainty surrounding bilateral relations with the U.S. is putting investment decisions on hold, and fiscal consolidation - which is taking a toll on non-residential construction - is yet to run its course. On the bright side, stronger U.S. industrial output and a competitive real exchange rate are already boosting the growth of Mexico’s manufacturing, which we believe will be the main buffer of the economy in 2017. Full Report
  • The minutes from the central bank’s April monetary policy meeting confirm that a deteriorated growth outlook, declining inflation expectations - resulting in an even more contractionary real rate - and disinflationary process underway, were behind the rate cut to 6.5% at the meeting. However, the 4-2 split in the board regarding the choice of a 50bp or 25bp cut was mainly due to the minority showing preference for a more cautious approach amid sticky inflation. At the meeting, the technical staff lowered the country’s growth outlook for this year to 1.8%, from 2.0%, which seemingly convinced the majority of the board that a more aggressive action was warranted. Beyond sticky inflation, the minority at this meeting showed preoccupation with communication of monetary policy to the market. This group favored a gradual and prudent easing cycle (in the form of a 25-bp cut) as elevated inflation and persistent indexation could prevent the central bank from fulfilling its objective (3% inflation target) in the policy horizon. Moreover, they preferred not to surprise the market, as they considered this would reinforce the proper functioning of monetary policy transmission. The concern came after the central bank’s decisions surprised the market in three of the preceding four months (between December and March).
  • 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% (100bps below the current level). Disappointing growth and declining headline inflation will be arguments for larger rate cuts, however, the unfavorable behavior of core and non-tradable inflation measures will likely drive at least some in the board to call for a more cautious approach ahead. An additional element of surprise will be the arrival of José Antonio Ocampo to the central bank this month (filling the seventh seat at the board). Therefore, we cannot rule the possibility the policy rate ends the year below our call. Full Report
  • Industrial production growth slowed in 1Q17 and was even weaker once the principal oil-refining driver is excluded. Activity in March surprised both the market and our 2.5% forecast, with growth of 4.8% (-3.4% in February). However, once corrected for seasonal and the favorable calendar effect (two extra working days), industrial production fell 2.3%. In the 1Q17, industrial production grew a mild 0.4%, down from 1.7% in 4Q16 and contracted 1.1% if oil refining is removed. Oil refining, excluding blending, grew 7.7% in the quarter, down from growth of 12.9% in 4Q16 (29.5% in 3Q16). The slowdown is no real surprise, considering that it has been a year since operations resumed at the Cartagena Refinery. Overall, the weakness is widespread with 58% of the product classes posted a contraction in the quarter (45% in 1Q16). At the margin, industrial production contracted 7.3% qoq/saar (+4.1% in 4Q16).
  • Retail sales came in line with our expectation in the month of March, leading to a notable slowdown in the quarter. Retail sales grew 1.9% year over year in March (-7.2% in February), close to our 2.0% forecast and exceeding the 1% market consensus. Activity in March was lifted by household durable goods sales, contributing 1.6 percentage points to the total headline gain. In the quarter, retail sales declined 2.4% year over year (+3.7% in 4Q16), pulled down by fuel and vehicle sales. Once both are excluded, retail sales contracted 1.4% (+2.3% in 4Q16). The implementation of the increased sales tax could explain weaker activity in the quarter. A significant 80% of the retail divisions registered contractions in the quarter, a notable rise from 13% in 1Q16. Adjusting for seasonal and calendar effects, retail sales excluding fuel sales, fell 13.1% qoq/saar, from +21.2% qoq/saar in 4Q16.
  • The weak performance from activity indicators is in line with GDP growth slowdown to 1.8% this year, from 2.0% in 2016. Low oil investment, a loosening labor market, historically low private sentiment and a still-tight monetary policy stance will curb growth this year. In 1Q17, activity likely grew at the lowest rate since the global financial crisis, keeping the central bank’s concern for an excessive slowdown elevated and in line with further monetary easing ahead. Full Report
Market Developments 
  • GLOBAL MARKETS: Treasuries narrowed as US core CPI indicates another soft core PCE print (0.12% m/m) in April, bringing it down to 1.5% YoY (from 1.6%). For the 5-year and 10-year, rates went down 6bps to 1.85% and 2.33%, respectively. However, core retail sales rose 0.2% m/m in April, but the surprise was due to softer core goods inflation (CPI commodities ex-food & energy: -0.2% m/m). In addition, core retail sales was revised up in March (0.7%, from 0.6%) and February (-0.2%, from -0.3%). All in all, as 2Q17 GDP rebound is on track, the Fed is expected to hike in June, but a gradual pace was reinforced by weaker core inflation trends. One additional rate hike in 2017 (September), after the one in June, remains likely, but risks look more balanced in the near term. The Fed funds implied probability of a hike in June slightly decreased to 97.5% from 100% on Thursday. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities traded higher as oil slightly increased (Brent: +0.16 to USD 50.85/bbl). Copper prices increased 0.78% after solid Chinese figures. Credit data came with stronger aggregate financing (1,390 billion; consensus: 1,150; our call: 1,105) and somewhat better new loans headline (1,100; consensus: 815; our call: 800). In FX, currencies posted gains after another weak U.S. core inflation print hurt the dollar. Hence, all currencies under our coverage appreciated. The MXN is trading 0.09% higher to 18.82/USD. The CLP posted mild gains to 671.35/USD (+0.10%). The COP strengthened 0.35% to 2,918.33/USD. The BRL appreciated 0.56% closing at 3.1224/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads for the 5-year tenor narrowed were mixed in LatAm. CDS in Mexico went up 1bp to 118bps. Meanwhile, Colombian and Chilean spreads stood flat at 130bps and 73bps, respectively. On the other hand, country risk in Brazil narrowed further to 203bps (-2bps). External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian yields narrowed for the fourth consecutive session after weak PMS figures add to batch of weak data in March (see Macro Backdrop). The Jan-18 fell 4bps to 9.14% and the Jan19 went down 6bps to 8.95%. Long real rates narrowed further as the May-55 fell 7bps to 5.08%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican rates narrowed tracking US Treasuries. In TIIE swaps, the 1-year fell 6bps to 7.27% and the 5-year decreased 7bps to 7.22%. Breakevens also narrowed as the 3-year went down 3bps to 3.98%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields fell 1-2bps in the session. In Camara swaps, the 1-year went down 2bps to 2.57% and the 6-year fell 1bps to 3.73%. Chile Rates Tracker In Colombia, on the other hand, rates widened as March industrial production came in weaker-than-expected (see Macro Backdrop). In IBR Swaps, the 6-month went up 4bps to 5.55% and the 5-year increased 4bps to 5.45%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, Lower House Speaker Rodrigo Maia (DEM) said that he will announce, sometime during the week, the Social Security reform’s voting schedule in the Lower House. The market will also remain focused on the news flow about the political negotiations surrounding the reform. On economic activity, CAGED formal job creation for April may come through. For April, we expect net destruction of 56k jobs seasonally adjusted. Our forecast may change following Industry Employment Data for the State of São Paulo (FIESP) (Wed.). Furthermore, the BCB will release its monthly activity index (IBC-Br) for March during the week, for which we expect a 0.6% decline month-over-month seasonally adjusted. Finally, industrial business confidence (CNI) for May will be released (Wed.) - we expect the current upward trend to continue.
  • In Mexico, the Central Bank’s board will meet to decide on the reference rate (Thu.). It will be hard for Banxico’s board to pause the hikes given the latest inflation data. Therefore, we expect Banxico to deliver a 25-bps rate hike (to 6.75%), in contrast with market expectations of no action.
  • In Chile, the central bank will publish the 1Q17 GDP (Thu.). The monthly GDP proxy recorded growth of 0.2% in the quarter, down from 0.5% in in 4Q16. The central bank will also publish the 1Q17 current account (Thu.). We expect a USD 700 million deficit, down from the USD 363 million surplus in 1Q16, mainly on the back of a smaller trade balance surplus in the quarter (USD 1.2 billion in 4Q16, after USD 2.2 billion in 1Q16). Finally, the central bank of Chile will hold its May monetary policy meeting (Thu.). We believe that sticky core service inflation and a favorable activity surprise gives leeway for a pause at this month’s meeting, so leaving the policy rate at 2.75%.
  • In Colombia, the central bank will present its quarterly inflation report (Mon.). It will be key to see if reference is made to the stickiness of core inflationary measures as this could be a relevant driver behind the pace of future rate cuts. Then, think-tank Fedesarrollo will release the April consumer confidence (Tue.). The depressed consumer sentiment hints at no quick recovery in private consumption related activity, thereby keeping the central bank’s concern over activity elevated. Moreover, the trade balance for the month of March will be published (Thu.). We expect a trade deficit of USD 780 million, smaller than the USD 1.1 billion deficit recorded one year ago. As a result, the trade deficit in 1Q17 would come in at USD 2.3 billion, narrowing from USD 3.6 billion in 1Q16. Going forward, the national statistics authority will publish the supply-side breakdown of GDP growth for 1Q17 (Fri.). Based on activity indicators for the quarter, we estimate activity fell 0.1% from the previous quarter, resulting in annual growth of 1.4%, down from the 1.6% in 4Q16. Finally, the March activity coincident indicator (ISE) will be published (Fri.). Recent indicators reaffirmed that the economy was weak in the first quarter of the year. In the previous month, ISE grew a mild 0.3% year over year. 

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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