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Mexican rates narrow as Banxico signals the tightening cycle is over

June 22, 2017

Mexican yields took the route south after the central bank asserted that the its baseline scenario is not to hike anymore.

With information available until 6:30pm Brasilia time

Highlights

  • Mexican yields took the route south after the statement accompanying the central bank decision asserted that the authority’s baseline scenario is not to hike anymore (see Macro Backdrop). Accordingly, the belly of the TIIE swaps curve rallied by double-digit figures. The 2-year compressed 23bps to 6.97%, while the 5-year dropped 19bps to 6.86%.
  • In Brazil, the front end also narrowed, as markets took the emphasis of inflation report on the data-dependency of its BCB’s reaction function as sign that the next Copom decision is next open between a 75-bp and a 100-bp cut (see Macro Backdrop). In DI futures, the Jan-18 tightened 4bps to 8.97%. The curve implies 86bps in rate cuts for the July 25-26 monetary policy meeting and 175bps of easing for the remainder of the year.

Macro Backdrop

BRAZIL
  • BCB's Inflation Report (IR) for 2Q17 stresses the central bank’s reaction function and sensitiveness to marginal data releases. The report updates forecasts, as usual, showing inflation at 4.5% at the end of 2018 and at 4.3% by 2Q19 in the active scenario, with interest rate and exchange rate forecasts in line with the Focus survey. In the hybrid scenario, with a constant BRL and the interest rate following market expectations, forecasts are at 4.3% for end-2018 and 4.2% for 2Q19. These forecasts seem to embed above-consensus views on administered prices, hence may move down over time. Be that as it may, they are consistent with a continuation of the easing cycle, towards the 8.5%-8.0% neighborhood by year-end. Interestingly, the text refers to the signaling of deceleration, presented in the latest policy meeting statement and minutes, in the past tense, indicating that the next Copom decision is officially open between a 75bps and a 100bps move. Full Report
  • The preview for June’s business confidence in the industrial sector (FGV) fell 2.3 pp to 90.0. Additionally, the indicator remains below the level perceived as neutral (100). The break down shows a drop of 1.3pp in the current situation component and 3.2pp from the expectations component. Capacity utilization (NUCI) fell slightly in the month (-0.1 pp), remaining well below the historical average. The final reading will come through on June 28.
  • BCB placed the full offering of 8,200 FX swaps. After closing, it announced another roll over auction of up to 8,200 (USD 410 million) contracts on June 23.
MEXICO
  • Banxico raised the reference rate by 25bps (to 7%), in line with our call and market expectations, but - more importantly - it signaled that the monetary tightening cycle is likely over. The forward guidance paragraph features a new sentence, which signals the intention to stop: “the Board considers that given today’s increase, and taking into account the transitory nature of the shocks, the fact that monetary policy acts on prices with lags, and the central bank’s own forecasts, the reference rate has reached a level that is consistent with the convergence of inflation to the 3% target”. Put simply, Banxico's baseline scenario is not to hike anymore. Granted, June’s statement also spells out that the Board is “vigilant to ensure a prudent monetary policy”, so the doors for hikes are not completely shut. Be that as it may, in our view, the bar for more rate increases has been set significantly higher, meaning that only large upside surprises on inflation could lead the board to hike again. Importantly, another change in the statement is that the balance of risks on inflation is now considered neutral (whereas May’s statement mentioned that this balance had deteriorated).
  • Against this backdrop, we have revised our monetary policy rate forecast for 2017 to 7% (from 7.25%). We see the policy rate in Mexico stable throughout the rest of this year (previously we saw one additional 25-bp rate increase in August). But considering the contrasting views within the board (revealed in the minutes), with two other board members believing that the tightening  cycle cannot end until inflation starts trending down, we expect split decisions ahead. Full Report
  • In the first half of June, CPI posted a 0.15% bi-weekly variation in line with our expectation and slightly above market consensus. The figure exceeded its 5-year median (-0.04%) by a wide margin, pressured by the 0.03% increase in agricultural prices (5-year median: -1.1%). Core goods and core services advanced 0.18% and 016%, respectively, contributing 6bps and 7bps to the bi-weekly print. The annual headline inflation increased to 6.30% (from 6.16% in the second half of May), whereas the core stood broadly unchanged at 4.82% during the same period. The diffusion index (percentage of items with annual inflation higher or equal to 4%) increased to 75.9% (from 74.3% in the second half of May), evidencing pressure remains broad-based.
  • We expect annual inflation to stabilize around the current levels, before starting a downward trend (ending the year at 5.4%). The appreciation of the MXN will be the main driver for lower inflation. Weaker activity (particularly domestic demand) in coming quarters and the recent decrease of oil prices will also exert some downward pressure. Moreover, the significantly tighter monetary policy (375bps in rate hikes since December 2015), will contribute to keep inflation expectations in check. Full Report

COLOMBIA

  • The coincident activity indicator (ISE) for the month of April continued to reflect weakness. The seasonally adjusted series grew a mild 1.4% year over year (-0.7% in March), resulting in growth of 0.6% year-to-date (2.7% in the 2016 equivalent period). Sequentially, activity fell from the previous month for the fifth consecutive time, resulting in quarterly activity declining 3.5% qoq/saar in the quarter ending in April (down from -1.9% in 1Q17 and +3.1% qoq/saar in 4Q16). We expect GDP growth of 1.6% this year, a slowdown from the 2.0% recorded last year.
  • In May, business confidence worsened, hinting that an activity recovering is unlikely in the short-term. According to think-tank Fedesarrollo, industrial confidence came in at -8.8% (0 is neutral), below the +5.2% recorded one year earlier and the lowest May recording since 2009. Seasonally adjusted, industrial confidence decreased 0.5pp from the previous month, moving deeper into negative territory. All three components of industrial confidence deteriorated from the levels recorded one year ago.
  • Meanwhile, retail confidence continues to decline, owing to the deterioration of current business activity. The index fell to 15.3% in May, from 28.5% one year ago. All in all, activity in Colombia has disappointed and we expect confidence levels to remain low in the months ahead.
Market Developments 
  • GLOBAL MARKETS: Risk appetitive recovered at the margin; volatility measures edged down and EM equity indexes traded on the green. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Oil paid back to the losses in the previous sessions, as Brent crude gained 0.96% to USD 45.252/bbl. Hence, oil-exporters led gains (MXN: +0.68% to 18.12/USD; COP: 1.01% to 3,027.61/USD). The CLP also appreciated a tad (0.25% to 663.63/USD), whereas the BRL weakened 0.19% to 3.3422/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm 5-year CDS spreads underwent some correction. Brazilian and Colombian risk premiums edged down 3bps to 243bps and 136bps, respectively. Elsewhere, spreads fell 2bps (Chile: 68bps; Mexico: 113bps). External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Yields narrowed in the front end, as markets took the emphasis of inflation report on the data-dependency of its BCB’s reaction function as sign that the next Copom decision is next open between a 75-bp and a 100-bp cut (see Macro Backdrop). In DI futures, the Jan-18 tightened 4bps to 8.97%. The curve implies 86bps in rate cuts for the July 25-26 monetary policy meeting and 175bps of easing for the remainder of the year. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican yields took the route south after Banxico signaled the tightening cycle is over (see Macro Backdrop). In TIIE swaps, the 1-year narrowed 18bps to 7.24%, while the 5-year dropped 19bps to 6.86%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, Camara swaps traded in ranges again. Chile Rates Tracker In Colombia, the IBR swaps curve bull-steepened, after high-frequency activity indicators continue to reflect weakness (see Macro Backdrop). The 1-year fell 4bps to 5.07% and the 5-year edged down 2bps to 5.36%. The curve implies 125bps in rate cuts until YE18.Colombia Rates Tracker

Friday Events

  • In Brazil, June’s IPCA-15 consumer inflation preview is the key release. We forecast a 0.14% monthly rise, with year-over-year inflation slowing to 3.5% from 3.8%. With this result, inflation will have reached 1.6% in the first half of the year, well below the 4.6% recorded during the same time window last year.
  • In Mexico, April’s retail sales will hit the wires.We forecast growth in sales at 1.5% year-over-year (down from 6.1% in March).

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza



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