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Mexican assets outperform amid state election results

June 5, 2017

The MXN rallied 1.84% to 18.38/USD, testing levels last seen in mid-September 2016.

With information available until 6:30pm Brasilia time


  • In Mexico, country risk fell 6bps to 113bps as the result of Sunday state elections reduced market expectations of a scenario of discontinuity in macroeconomic policies after the 2018 presidential elections. Also, the MXN rallied 1.84% to 18.38/USD, testing levels last seen in mid-September 2016. According to Reuters, the PRI candidate del Mazzo received 33.7% of votes against 30.8% for Morena’s Delfina, with 98% of ballots counted by the time of writing. In rates, the curve bull flattened, in contrast with US treasuries. In TIIE swaps, the 1-year fell 7bps to 7.45% and the 5-year went down 13bps to 7.23%. 
  • In Brazil, the curve bear steepened again. In DI futures, the Jan-18 widened 2bps to 9.42% and the Jan-21 went up 6bps to 10.62%. Real rates also widened as the May-21 went up 6bps to 5.70%. The BRL was the laggard among the majors, closing at 3.2966/USD (-1.54%).

Macro Backdrop

  • 2017 inflation expectations adjusted downwards. According to BCB’s Focus survey, inflation expectations for 2017 dropped to 3.90% (-5bps), and remained stable for years ahead. Year-end Selic expectations stood flat at 8.50% for 2017, 2018 and 2019. The market sees a weaker BRL at 3.30/USD by YE17 (previous: 3.25/USD), at 3.40/USD by YE18 (previous: 3.37/USD) and at 3.47/USD by YE19 (previous: 3.45/USD). At last, GDP growth expectations inched up to 0.50% for 2017 (previous: 0.49%) and deteriorated to 2.40% for 2018 (previous: 2.48%). See BCB Report
  • After closing, the BCB announced a roll over auction of up to 8,200 FX swaps on June 6. If this pace is maintained throughout the month, the central bank will have rolled over 100% of the outstanding amount expiring in July (USD 6.9 billion).
  • Gross fixed investment weakened significantly in 1Q17, dragged by the fiscal consolidation and the uncertainty surrounding bilateral relations with the U.S. (which puts investment decisions on hold). According to calendar-adjusted data reported by the statistics institute (INEGI), gross fixed investment contracted 2% y/y in 1Q17 – the weakest print in over three years – after expanding 1.4% y/y in 4Q16. At the margin, seasonally-adjusted gross fixed investment fell 1.6% from the previous quarter, posting a quarter-over-quarter annualized contraction of 6.2% (way below the 2.4% qoq/saar expansion in 4Q16). Looking at the breakdown, construction (-9.7% qoq/saar) is doing much worse than investment in machinery & equipment (-0.5% qoq/saar). Within construction, the weakest link is non-residential construction, which is vulnerable to the fall of public investment. Looking ahead, we expect a further weakening of gross fixed investment. The uncertainty surrounding bilateral relations with the U.S. already seems to be affecting foreign direct investment (down by -26.1% y/y in 1Q17) and the fiscal consolidation implies that public investment will continue to fall.
  • Mexico’s consumer confidence improved in May, but remains subdued. The consumer confidence came in at 86.8 – above market expectations of 84.6 – but stands 4.5% below the level recorded in the same month of 2016. At the margin, nevertheless, seasonally-adjusted consumer confidence increased 2.2% from the previous month. We attribute this improvement to the strength of formal employment, which remains growing above 4% y/y, and more sanguine views about bilateral relations with the U.S. (given the more conciliatory tone of U.S. policymakers over the past months, in contrast with the diplomatic row of early 2017). Interestingly, the significant increase of inflation from 4.7% y/y in January to 6.2% y/y in the first half of May (highest in 8 years) did not prevent consumer from showing a consistent improvement during the same period. Looking ahead, we expect high inflation (eating through real wages), rising domestic interest rates (affecting household credit), and softer labor market conditions (which should deteriorate as a consequence of weaker investment) to keep consumer confidence at low levels.
  • Weak activity in April beyond calendar effects. The Imacec (monthly proxy for GDP) grew 0.1% year over year in April (0.3% in March), falling in between our -0.5% forecast and market consensus of +0.7%. Once adjusted for calendar effects, economic growth was better, but still weak. The 0.1% annual rise was aided by the 0.4% increase in non-mining activity (+2.3% in March) and a smaller drag from mining (-4.0%, from -23.2% in March), due to the end of the strike at Chile’s largest copper mine.  In the quarter ending in April, the cumulative effect of the mining strike (-15.2% year over year) dragged overall activity down to -0.3% (+0.1% in 1Q17, +0.5% in 4Q16), while non-mining activity grew 1.0% (1.4% in 1Q17, 0.8% in 4Q16).
  • We expect activity to pick-up in the months ahead as the drag from the mining strike is left behind. However, due to the weak start of the year, we see a poor expansion of 1.6% in 2017. Overall, the low levels of inflation and the loose monetary policy, alongside higher average copper prices in the year (vs. 2016), will aid activity. However, downside risks persist, especially given the still-low confidence levels amid uncertainties over reforms and the political scenario. Full Report
  • The central bank’s second quarterly inflation report (IPoM) of the year confirms that the easing cycle has concluded, while a normalization process is not on the near horizon. The central bank implemented a 100-bp easing cycle (to 2.5%) in the first five months of the year as the economy weakened, while inflation remained under control. The board appears content to wait and observe how the economy unfolds given the additional monetary stimulus. The baseline trajectory for the policy rate considered by the central bank is one coherent with the expectations seen in various surveys in the lead up to the publication of the report. This means the policy rate would remain stable at 2.5% during the remainder of this year and at least 1H18, before edging up towards 3.0%-3.25% by mid-2019, broadly in line with our baseline scenario. With the negative impact from the Escondida mine strike and disappointing investment in 1Q17, the central bank narrowed the 2017 growth range to 1.0%-1.75% from 1.0%-2.0%, previously. Next year, growth would improve to 2.5%-3.5% (2.25%-3.25% in the 1Q17 report). The expected recovery of Chile’s trade partners’ activity (3.3% this year, from 2.9% in 2016, and 3.4% in 2018) and the stabilization of copper prices (USD 2.55 per pound this year and USD 2.50 in 2018) would support the recovery ahead. The central bank continues to see Chile’s short-term potential growth rate between 2.5% and 3.0%, while the long-run trend growth stands at 3.2%.
  • The board considers the risks to growth are balanced. We note that in the Financial Stability Report released today, the bank acknowledges that non-performing loans have shown deterioration from the close of 2016. With the economy remaining weak and the labor market still adjusting, there is a risk of a further deterioration in the credit variables, curbing the recovery. In all, we expect the central bank to keep the policy rate at 2.5% until at least 2H18. However, as the economy remains weak and inflationary pressures contained, further rate cuts this year remain a possibility in our view. Full Report
  • Business confidence is showing signs of a mild improvement. Although think-tank Icare’s May business confidence index remained in pessimistic territory (below 50) for the 38th consecutive month, it picked up over 3 percentage points from May 2016 to reach 44.9 points (previous: 44.1). This was the third consecutive month business sentiment has been above the level recorded one year prior. There was widespread improvement in all the sub-indexes with mining confidence remaining in optimistic territory at 65.5 points (64.2 one year ago). Commercial confidence sits near the neutral level at 48.6 points (up 3.1 points in 12 months), while industrial confidence increased 4.2 points to 42.3 points. Construction confidence rose 3.3 points, but is still languishing deep within the pessimistic zone at 24.2 points. Our expectation of an activity recovery into 2018 considers a confidence improvement that would lead to a better investment performance.
Market Developments 
  • GLOBAL MARKETS: The non-manufacturing ISM fell to 56.9 in May, a touch below consensus expectations (57.1) and below April’s 57.5 reading. Despite the monthly decline, the index remains well in the expansionary territory, and in-line with the 6-month moving average of 56.7. Hence, US treasuries widened as the 5-year went up 2bps to 1.74%. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities traded lower in the session tracking oil (WTI: -0.65% to USD 47.35/bbl) and metals (copper: -0.52%; iron ore: -1.31%). In FX, currencies were under our coverage were mixed. Andeans remained broadly stable (COP: -0.08% to 2,898.05/USD; CLP: +0.13% to 668.65/USD). The BRL was the laggard, closing at 3.2966/USD (-1.54%). Finally, the MXN (+1.84% to 18.34/USD – testing levels last seen in mid-September 2016) rallied after the result of Sunday state elections reduced market expectations of a scenario of discontinuity in macroeconomic policies after the 2018 presidential elections. Alfredo del Mazzo, of the ruling party (PRI), seems to have won the State of Mexico elections against Delfina Gómez Álvarez (Morena). According to Reuters, the PRI candidate received 33.7% of votes against 30.8% for Morena, with 98% of ballots counted by the time of writing. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm Credit spreads for the 5-year tenor were mixed. Chilean spreads inched down 1bp to 68bps – lowest level since August 2016. In Colombia, CDS fell 2bps to 125bps. In Mexico, they narrowed substantially to 113bps (-6bps) as the ruling party won the State of Mexico election over the weekend. Bucking the regional trend, Brazilian country risk inched up 1bp to 238bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bear steepened again. In DI futures, the Jan-18 widened 2bps to 9.42% and the Jan-21 went up 6bps to 10.62%. Real rates also widened as the May-21 went up 6bps to 5.70%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve bull flattened, in contrast with US treasuries. Also pressuring rates, MXN appreciated and country risk improved substantially. In TIIE swaps, the 1-year fell 7bps to 7.45% and the 5-year went down 13bps to 7.23%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, rates widened 1-2bps. In Camara swaps, the 1-year increased 3bps to 2.46% and the 5-year inched up 1bp to 3.39%. Chile Rates Tracker In Colombia, yields fell 2-4bps in the session. In IBR swaps, the 9-month fell 2bps to 5.27% and the 7-year went down 4bps to 5.38%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, the Supreme Electoral Court (TSE) will resume the trial that is analyzing the request to annul the Dilma Rousseff/Michel Temer presidential ticket (Tue.). On the same day, the Senate’s Economic Affairs Committee will vote the labor reform. Then, the Copom minutes will be released (Tue.). In its last meeting, the Copom cut the Selic rate by 100bps to 10.25% p.a., without bias, in a unanimous and a widely expected decision. We'll learn more about the reasoning behind the Copom decision with the release of these minutes. Then, May’s IPCA consumer inflation will be released (Fri.). We forecast a 0.48% monthly rise, with year-over-year inflation slowing to 3.8% from 4.1%. Moreover, economic activity indicators will see a less busy week following the 1Q17 GDP release. Anfavea will release May auto production (Tue.) - we forecast 236k units were produced. Serasa may release its May retail activity index (Wed.), an important coincident indicator for IBGE’s retail sales. Finally, IBGE will release the monthly update of its Systematic Survey of Agricultural Production (Thu.).
  • In Mexico, the statistics institute (INEGI) will announce May’s CPI (Thu.). We expect a 0.13% month-over-month decline in the CPI, driven by the 23.3% reduction of regulated electricity tariffs by the Federal Electricity Commission (CFE) and the decrease of gasoline prices. Assuming our forecast is correct, annual inflation would increase to 6.15% year-over-year (from 5.82% in April). Finally, INEGI will publish April’s industrial production (Fri.). We expect a 2.8% year-over-year contraction (down from a 3.4% expansion in March), based on a deterioration of coincident indicators and a negative calendar effect. 
  • In Chile, the central bank will release the trade balance figures for May (Wed.). We forecast a USD 470 million surplus (USD 564 million surplus in May 2016), taking the rolling 12-month trade balance to USD 3.9 billion (USD 5.3 billion in 2016). Moreover, the National Institute of Statistics (INE) will publish nominal wage growth for April (Wed.). Wage inflation has gradually moderated as the labor market loosens, the economy cools and inertia stays low (as inflation is running below the target). Finally, inflation for the month of May will be published by the National Institute of Statistics (Thu.). We expect prices to be flat from April (+0.2% in April). As a result, annual inflation would dip to 2.4%, from 2.7% previously, closer to lower bound of the 2%-4% tolerance range.
  • In Colombia, Banrep will release the minutes of the monetary policy meeting held in May (Fri.). At the meeting, a split board decided to cut the policy rate by 25-bps to 6.25%, less aggressive than the 50-bp cut in the previous month. A tick-up in inflation expectations and sticky core consumer prices have created some unease in the board. Nevertheless all board members were in favor of further easing. The minutes will likely reflect heightened concern for inflation dynamics.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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