Itaú BBA - Markets see deeper Selic cuts ahead after weak IP data

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Markets see deeper Selic cuts ahead after weak IP data

May 3, 2017

For the next Copom, the market is pricing in 114bps in rate cuts. For the remainder of the year, the curve implies roughly 244bps in rate cuts.

With information available until 6:30pm Brasilia time

Highlights

  • In Brazil, the very front end narrowed as industrial production came in below the most pessimistic forecast (see Macro Backdrop). In DI futures, the Jan-18 went down 4bps to 9.40% and the Jan-19 fell 2bps to 9.29%. For the next Copom, the market is pricing in 114bps in rate cuts. For the remainder of the year, the curve implies roughly 244bps in rate cuts. In Chile, on the other hand, the curve bear steepened as retail sales topped the most optimistic forecast (see Macro Backdrop). In Camara swaps, the 1-year widened 8bps to 2.51% and the 5-year decreased 3bps to 3.37%. 
  • In LatAm FX, most currencies under our coverage depreciated. The COP, however, posted gains of 0.41% to 2,930.43/USD. Then, the MXN is trading 0.50% lower to 18.86/USD and the CLP posted losses of 0.17% to 669.34/USD. In the voting day of the pension reform in the special committee, the BRL was volatile closing at 3.1662/USD (-0.47%). By the time we wrote this piece, headlines point to the voting of the core text to take place still Wednesday.

Macro Backdrop

BRAZIL
  • Industrial production dropped 1.8% mom/sa in March, below our forecast (-0.7%) and market estimates (-1.0%). Compared to March 2016, the indicator went up 1.1%. The breakdown by economic category showed a widespread decline, reaching durable consumer goods (-8.5%), other consumer goods (-1.8%), capital goods (-2.5%), and intermediate goods (-2.5%). The breakdown by activity pointed to drops of 1.7% in manufacturing and 1.1% in extraction and mining. On a more detailed breakdown, only nine out of 24 activities posted monthly gains. Pharma-chemicals and pharmaceuticals stood out, as production tanked 23.8% mom/sa and contributed approximately -0.6 p.p. to the March aggregate reading. This segment’s performance explains why the aggregate result was worse than diffusion suggested. Construction material production fell 1.6% mom/sa and 3.6% yoy. 
  • Coincident indicators point to stagnation in April. Available coincident indicators (capacity utilization, vehicle sales, weekly foreign trade figures, power consumption) point to a gain of 0.2% mom/sa in April, which would be insufficient to offset the negative statistical carryover from March (-1.2%). The heat map shows a scenario of stagnation, reversing some of the improvement seen in the first two months of the year and a better picture than in the previous quarter. Full Report
  • Our Itaú Activity Surprise Index inched up to 0.12 in April from 0.11 in March, led by a methodological distortion in Brazil’s retail sales number. The tone of surprises is negative in general throughout the region. Mexico’s positive surprises are declining in magnitude but data still shows resilience to shocks, whereas Colombia returns to a rough patch, displaying similar deterioration seen in mid-2016. Results continue alluding to a sluggish pickup in activity. Full Report
CHILE
  • The decision to cut the monetary policy rate by 25-bps in April was unanimous, according to the meeting’s minutes. The central bank embarked on a 50-bps easing cycle in 1Q17, following the guidance included in the 4Q16 Inflation Report (IPoM). The board noted that if falling waged employment and wages endured, they could have a negative effect on consumption ahead. In the same line, another participant noted that an additional deterioration of the labor market constituted a risk factor for this year and the next one. These comments reaffirm our view that the evolvement of the labor market was the likely trigger of the rate cut last month, and would play a similar role going forward. Meanwhile, the evolution of inflation was not a source of concern. Different board members discussed varying forces behind the recent disinflation, with one highlighting the role played by the appreciation of the CLP. This member added that the enduring relative strength of the currency could further push inflation readings down in coming months, cautioning on the appropriate monetary policy response in this scenario.
  • Overall, we view that the central bank has a clear, but certainly limited, appetite for additional easing. We expect the policy rate to reach 2.50% before the end of the quarter and remain there until the end of the year. However, we acknowledge that if activity, particularly through the labor market, disappoints further, additional easing might be on the cards. Full Report Below
  • Private consumption related activity performed more favorably in March, but activity continued to moderate in the quarter. The commercial activity index - aggregating vehicle, retail and wholesale activity - increased 4.9% year over year. This came in above our forecast of a 1% increase and the downwardly revised 2.3% contraction in February, and was likely boosted by a favorable calendar effect. In first quarter of the year, commercial activity growth slowed to 2.2% (3.0% in 4Q16), dragged down by wholesale growth dropping to 0.4% (+2.8% in 4Q16). In retail sales, the 4.9% expansion (-1.6% in February) pulled commercial activity up (2.0 percentage point contribution to the aggregate gain). The performance in the month was driven by sales in non-specialized stores as well as apparel. Vehicle and part sales increased 13.8% year over year (+1.1% previously), led by the 27.1% rise in car sales (11.7% previously). Meanwhile, the 12.7% decline in parts remains a drag. Wholesale activity grew 2.4% (-3.9%), lifted by sales of domestic equipment. 
  • We expect private consumption to moderate ahead as the labor market -particularly salaried employment growth- weakens and nominal wage growth slows. While, this could be partly countered by low levels of inflation and an expansionary monetary policy, activity this year will likely remain frail. On the back of the better than expected data, we see the monthly GDP proxy for the month to show a 0.5% annual drop in March (-1.3% in February). Full Report Below
  • Business confidence continues to languish in pessimistic territory, intimating that an activity recovery is not on the near horizon. Think-tank Icare published its business confidence index for April, which came in at 44.1 (50 is neutral), from the 43.3 one year ago (45.1 in the previous month). Confidence has now completed 37 months in pessimistic territory. Construction confidence in still the lowest sub-index (22.1), following the end of the tax-incentivized real estate boom. Industrial confidence is at 41.1, meanwhile, the commerce sub-index is marginally optimistic at 51.1 (47.4 one year ago). As inflation stays low and interest rates fall, commercial confidence could see an improvement ahead. Following the end of the spite of the labor strike at Escondida in March and still elevated copper prices, mining confidence remains high at 62.2. Depressed private sentiment – and resulting subdued investment – has played an important role in the activity slowdown. 
COLOMBIA
  • Export performance progressed in 1Q17, boosted by the recovery of natural resource prices. In the month of March, total exports rose 37.9% year over year (15.6% in February), with coal coffee and oil exports leading the charge. In the first quarter of the year, exports increased 31.4% year over year (13.7% in 4Q16). This is the highest moving quarter annual increase since the quarter ending in January of 2012, as commodity prices recover. Oil exports rose 46.3% in the quarter (1% in 4Q16), while coal exports nearly doubled from 1Q16 and coffee exports increased by 41.6% (43.3% in 4Q16). Meanwhile, exports excluding oil, coal, coffee, and ferronickel (Colombia’s traditional exports) continue to grow but at a slower rate (7.6% vs. 12.1% in 4Q16). We estimate that, at the margin, total exports increased at an annualized quarter over quarter rate of 21% (68% in 4Q16 and 5% in 3Q16), with the slowdown led by coffee exports. Going forward, we expect the higher average commodity prices this year and the weak internal demand to support a narrowing of the trade deficit. As a result, we see the current account deficit shrinking to 3.6% of GDP from the 4.4% of GDP last year.
Market Developments 
  • GLOBAL MARKETS: The FOMC stood on hold, as expected. The statement accompanying the decision was read as neutral, so the next hike in June remains the market base case - Fed Funds futures price in almost 94% odds of a hike in June. US Treasuries bear steepened (2s30s: +4bps) as the Fed communiqué characterized the deceleration in Q1 as “likely to be transitory”. The board acknowledged household spending rose only modestly but added that “the fundamentals underpinning the continued growth of consumption remained solid”. The Committee also noted that despite the decline in March, core inflation continues to run somewhat below 2%. Global Markets Tracker
  • CURRENCIES & COMMODITIES: As oil (Brent: +0.16% to USD 50.54/bbl) and soybean (+0.67%) prices increase, metals posted losses (copper: -4.42%; iron ore: -3.52%). In LatAm FX, most currencies under our coverage depreciated. The COP, however, posted gains of 0.41% to 2,930.43/USD. Then, the MXN is trading 0.50% lower to 18.86/USD and the CLP posted losses of 0.17% to 669.34/USD. In the voting day of the pension reform in the special committee, the BRL was volatile closing at 3.1662/USD (-0.47%). By the time we wrote this piece, headlines point to the voting of the core text to take place still Wednesday. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Most credit spreads for the 5-year tenor decreased in LatAm. CDS in Chile stood flat at 72bps. Country risk in Colombia inched down 1bp to 123bps and in Mexico they went down 2bps to 113bps. Meanwhile, Brazilian spreads narrowed the most to 210bps (-3bps) – lowest since January 2015. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Short rates narrowed as industrial production came in below the most pessimistic forecast (see Macro Backdrop). In DI futures, the Jan-18 went down 4bps to 9.40% and the Jan-19 fell 2bps to 9.29%. For the next Copom, the market is pricing in 114bps in rate cuts. For the remainder of the year, the curve implies roughly 244bps in rate cuts. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Short Mexican yields widened in the session. In TIIE swaps, while the 1-year decreased 4bps to 7.22%, the 10-year stood flat at 7.42%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, the curve bear steepened as retail sales topped the most optimistic forecast (see Macro Backdrop). In Camara swaps, the 1-year widened 8bps to 2.51% and the 5-year decreased 3bps to 3.37%. Chile Rates Tracker In Colombia, short rates fell and long widened. In IBR Swaps, the 1-year fell 4bps to 5.30% and the 5-year increased 4bps to 5.18%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, Anfavea will release data from the automobile sector in April (Fri.). The data helps to estimate industrial production and retail sales for that month.
  • In Mexico, 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 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. Then, 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, 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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