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LatAm FX weakens on US tax reform market expectations

October 26, 2017

The USD strengthened across the board (DXY: +0.91%; EM FX: -0.23%) after the US House approved the budget resolution, triggering a sell-off in Latam currencies.

With information available until 6:30pm Brasilia time


  • The USD strengthened across the board (DXY: +0.91%; EM FX: -0.23%) after the US House approved the budget resolution, triggering a sell-off in Latam currencies. The BRL depreciated 1.90% to 3.2973/USD, the MXN is trading at 19.2021/USD (-0.84%) and Andeans depreciated to a lesser extent (COP: -0.55% to 3,015/USD; CLP: -0.50% to 632.98/USD). 
  • In the day after a Copom meeting that brought little surprise (see Macro Backdrop), Brazilian yields widened substantially as the BRL sold off. In DI futures, the Jan-21 widened 23bps to 9.13%. Breakevens also went north (2-year: +6bps to 4.74%). 

Macro Backdrop

  • The House of Representatives blocked the second indictment filed by the former Prosecutor-General against the President. This time 251 representatives voted against authorizing the Supreme Court to put Mr. Temer on trial (263 in the first indictment), 233 lawmakers voted in favor and there were 29 abstentions. 
  • Copom: loud and clear, 7.0% by year-end. The Copom delivered the widely expected outcome, a 75bps rate cut to 7.5%, in an unanimous vote. In the statement, the Committee assesses that data released since the last policy meeting are consistent with a gradual economic recovery – indicating that, for the Copom, the economy is already post stabilization. 
  • The Copom notes that economic conditions and the stage of the easing cycle warranted a 75bps rate cut at this meeting. Looking forward to the next one, the committee states that with the economy performing as expected, and (importantly) still taking into account the stage of the cycle, it would be proper to moderately slow down the pace of easing – moderate reduction in pace meaning, judging by recent communication patterns, 25bps increments. The committee scraped the sentence that indicated its preference for a gradual end of the easing cycle, hinting that the next 50bps rate cut may be the last, or else that it may end with a 50bps move in February 2018.In our view, the Copom would begin 2018 with another cut, by 50bps, taking the Selic to 6.5% at the end of the cycle – although we concede that today´s statement hints at the cycle ending this year. Full Report
  • The central government posted a BRL 22.7 billion deficit in September, matching market expectations (BRL -22.7 billion) and better than our call (BRL -24.4 billion). The surprise came half from higher net-revenues (due to lower transfers to regional governments) and half from lower expenditures (in the discretionary line, still affected by the very strict budget cuts implemented by that time). The central government is very likely to meet the 2017 BRL 159 billion revised deficit target and hence focus will turn to 2018. The last event of extraordinary revenues will be Friday’s (October 27) oil fields auctions that should add around BRL 8 billion in revenues for this year. With improvement in activity and fulfillment in the extraordinary revenues front, government may also announce a new unfreeze in the budget in November. The focus will then turn to 2018, especially to the proposed measures involving public servants, taxation of closed funds and Eletrobras privatization that needs to be approved to allow the government to close a gap of around BRL 13 billion to comply with the BRL 159 deficit target (considering a 3.0% GDP as in our scenario). 
  • The consolidated primary result for September (including regional governments and state-owned companies) will be released on Monday (October 30). We expect a BRL 24.8 billion deficit, with regional governments posting a BRL 0.5 billion deficit and state-owned companies a BRL 0.4 billion deficit. 
  • The current account surplus came in at USD 434 million in September, well above our expectations (USD 600 million deficit) and the market consensus (USD 300 million deficit). Over 12 months, the current account deficit fell to USD 12.6 billion or 0.6% of GDP. Year-to-date, the current account deficit stood at USD 2.7 billion, the lowest reading in the historical series (since 1995). The seasonally-adjusted annualized quarterly moving average declined to USD 15.7 billion in September. The biggest positive contribution came once again from the trade balance, which posted a USD 4.9 billion surplus, up from USD 3.6 billion in September 2016. 
  • In the financial account, direct investment in the country (DIC) totaled USD 6.3 billion, in line with our estimates (USD 6.5 billion) and slightly above the market consensus (USD 6.0 billion). Equity capital transactions accounted for 87.9% of total DIC. Over in 12 months, DIC remains stable at around USD 83 billion. Preliminary data released by the BCB show that the DIC will probably remain at high levels next month (inflows of USD 5.5 billion until October 24). 
  • The strong trade surplus has been supporting a low current account deficit. We still expect high trade surpluses this year, but a rebound in domestic demand and lower commodity prices tend to produce weaker readings in the next months. Recent readings already point in this direction. On the financing side, direct investment in the country remains resilient and around USD 80-85 billion throughout the year, thus reducing dependence on more volatile capital. Nevertheless, portfolio investment flows (fixed income and equity) continue to show outflows over the past twelve months - albeit less intense than in recent months. Full Report
  • FGV’s construction survey shows a 0.6% confidence gain in October. The result was driven by stronger expectations (1.1%) while the current situation index stood flat. The confidence index is up for the 5th consecutive month, signaling that the mild recovery shown in construction hard data for 3Q17 may extend into 4Q17. 
  • The rolling 12-month trade deficit widened in 3Q17, as a larger energy deficit offset a growing non-energy surplus. The trade balance posted a USD 1.9 billion deficit in September, surprising median market expectations (USD -1.3 billion) to the downside. As a result, the rolling 12-month trade deficit widened (to USD 9.9 billion in 3Q17, from USD 9 billion in 2Q17), with a larger energy deficit (USD 17.1 billion in 3Q17, from USD 15.6 billion in 2Q17) wiping out a growing non-energy surplus (USD 7.2 billion in 3Q17, from USD 6.6 billion in 2Q17).  
  • We expect the 12-month trade deficit to resume a narrowing trend, reaching USD 7 billion in 2017. In our view, the driver will be stronger growth for manufacturing exports, attributable to a dynamic US economy (the ISM manufacturing index continued climbing in September, reaching the highest level in thirteen years). Moreover, the weakness of investment – exacerbated by the uncertainty associated to the fate of Nafta and the presidential elections – will probably curb imports of capital goods (and thus non-oil imports). A risk to our forecast, however, is the widening of the energy deficit. The main culprit for this trend is the fall of oil output. But we also note that the stoppage of the largest refinery which closed temporarily (due to a fire accident), and then in September because of the earthquakes, pressured oil imports. Full Report


  • Fitch affirms Colombia’s Long-Term Foreign Currency rating at BBB with a Stable Outlook. According to the agency, “the rating reflects Colombia's long track record of credible, flexible and consistent macroeconomic policies as well as a record of macroeconomic and financial stability”. Additionally, Fitch cited that “the fiscal deficit is on a downward path and Fitch expects the government to reach its revised central government fiscal deficit target of 3.6%. Its 2018 target of 3.1% of GDP is credible, based on expenditure restraint, especially in capital expenditures, as well as additional revenues from the tax reform that passed in December 2016”. 
  • Industrial confidence stayed in pessimistic territory in September. According to think-tank Fedesarrollo, industrial confidence came in at -3.4% in (0 is neutral), below the +2.5% recorded one year earlier. Of the three components of industrial confidence, the volume of goods ordered deteriorated, inventories ticked up, while on the other hand expectations for the next quarter became more optimistic. Once corrected for seasonal factors, industrial confidence remains in negative territory and fell 0.5 points from August. At the margin, the component regarding expectations was also the only one to demonstrate an improvement. On the other hand, retail confidence remains in optimistic territory, but continues to stay at historically low levels. Retail confidence in September was 15.8%, down 7.7 p.p. over twelve-months, the lowest September level since 2008. The decline over the last 12-months is once more due to the evaluation of current performance rather than expectations. Activity in Colombia has been weak, but there are signs that activity in the third quarter of the year is improving. Looking ahead, higher real wages (as inflation falls) and lower interest rates, along a favorable external environment, will likely help support a further recovery. We see economic growth of 1.6% this year (2.0% in 2016), with a pickup to 2.5% growth next year. 
Market Developments
  • GLOBAL MARKETS: EONIA rates narrowed (5-year: -4bps to 0.04%) and the EUR weakened (-1.38%) after the ECB meeting. As expected, the Committee reduced the monthly purchases (from EUR 60 billion to EUR 30 billion until September 2018) and kept forward guidance of low rates and accommodative policy for long. Moreover, the US House approved the budget plan, increasing market expectations of a tax reform, pushing the USD higher as well as global equity markets. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities were mixed in the session. While oil prices increased (WTI: +0.95% to USD 52.93/bbl), agriculture (wheat: -0.86%) and metals (iron ore: -2.87%) posted losses. LatAm FX weakened substantially on a strong USD day (DXY: +1.02% to 94.66 – strongest since July). The BRL was the regional laggard, closing at 3.2973/USD (-1.90%). The MXN is trading at 19.2021/USD (-0.84%) and Andeans depreciated to a lesser extent (COP: -0.55% to 3,015/USD; CLP: -0.50% to 632.98/USD). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads (5-year) widened all across LatAm. In Brazil, CDS increased 2bps to 175bbps. Colombian, Mexican and Chilean spreads inched up 1bp to 114bps, 109bps and 54bps, respectively. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: In the day after a Copom meeting that brought little surprise (see Macro Backdrop), Brazilian yields widened substantially as the BRL sold off. In DI futures, the Jan-21 widened 23bps to 9.13%. Breakevens also went north (2-year: +6bps to 4.74%). Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve bear steepened on the back of rising US Treasuries and a weaker MXN. In TIIE swaps, the long end widened 5-6bps (10-year: +5bps to 7.46%). Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: Chilean yields narrowed 1-3bps in the session; the 5-year Camara swap decreased 2bps to 3.52%. Chile Rates Tracker In Colombia, rates had a quiet session once again. In IBR swaps, the 1-year was flat at 4.74% and the 5-year inched up 1bp to 5.41%. Colombia Rates Tracker

Friday Events

  • In Colombia, Banrep holds its monthly monetary policy meeting. It remains likely that the majority of the board will opt to extend the pause (policy rate at 5.25%) in the easing cycle as it evaluates the inflation trend.

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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