Itaú BBA - Moody’s downgrades Brazil’s outlook to negative from stable

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Moody’s downgrades Brazil’s outlook to negative from stable

May 26, 2017

Moody’s changed outlook on Brazil’s Ba2 issuer rating to negative from stable.

With information available until 6:30pm Brasilia time


  • Moody’s changed outlook on Brazil’s Ba2 issuer rating to negative from stable. The agency cited “the rise in uncertainty regarding reform momentum following recent political events” as one of the driving factors to the decision. Moody’s sees a risk that such events could “undermine the government’s reform agenda and stall passage of future reforms, including social security. 
  • Brazilian yields narrowed on the back of short-term disinflationary shocks (see Macro Backdrop). In DI futures, the Jan-18 fell 20bps to 9.34% and the Jan-21 went down 27bps to 10.41%. For the Copom meeting next week (May 30-31), the curve implies almost 100bps in cuts, from 91bps as of Thursday (May 25). The BRL posted gains of 0.46% to 3.2602/USD.

Macro Backdrop

  • The central government posted a surplus of BRL 12.6 billion in April under the National Treasury’s methodology, topping our estimate (BRL 8.2 billion) and market expectations (BRL 7.2 billion). Over 12 months, the central government’s primary deficit remained at 2.4% of GDP. Year-to-date, the result is in line with last year. Compared to our forecasts, revenues were larger (by BRL 1.9 billion), while expenses were smaller than we anticipated (by BRL 2 billion). The discrepancy reflected larger revenues from oil royalties and lower discretionary expenses, confirming the government’s big effort to meet the target for the primary deficit in 2017, of BRL 139 billion. Excluding results related to FX swap transactions, interest expenses accumulated over 12 months stood at 7.4% of GDP in April. The nominal deficit remained at 9.7% of GDP, pressuring public debt. Including results with FX swap trading (gains shrank to 0.5% of GDP from 0.7%), the nominal deficit reached 9.2% of GDP. 
  • Public debt dynamics remained unfavorable. The general government’s gross debt edged up to 71.7% of GDP in April (March: 71.5%), while public sector net debt was unchanged at 47.7% of GDP. If approved, the pension reform will be essential for public debt dynamics — by reversing the current upward trend in pension expenses and being a key step to comply with the constitutional spending cap — and could generate the necessary conditions for the structural decline in interest rates and the rebound in economic activity. Full Report
  • Power regulator Aneel changed to green from red mode in the tariff flag system for June. Also, at refineries, gasoline (-5.4%) and diesel (-3.5%) prices were reduced. In all, given these developments, we revised our June IPCA forecast to 0.00% m/m (from: 0.25%). 
  • According to FGV, confidence in the construction sector fell 3.3% in May. The decline was evenly distributed between the current situation component (-3.0%) and expectations (-3.4%). After showing a mild improvement in 2Q16-3Q16, confidence in the construction has been stagnant at a low level. Seasonally adjusted capacity utilization in the sector has receded somewhat to a new minimum, suggesting weak production of typical construction inputs for the month.
  • Copom Cockpit: 100-bp cut amid uncertainties. With the significant rise in uncertainty regarding the approval of reforms, we now expect the Copom to deliver a 100-bp cut next week, thus maintaining the pace of the previous meeting, compared to past expectations of a sharper cut. It should be noted that the committee's decision is subject to new political developments, which affect asset prices and the prospective trajectory of inflation. In particular, if new events, up to the meeting day, worsen the chances of approval of the reforms and increase risk premiums on Brazilian assets, a moderate reduction in the easing pace should not be ruled out, although this is not our baseline scenario. Full Report
  • Macro Vision: we forecast 1Q17 GDP growth at 1.1%. Based on Itaú Unibanco’s monthly GDP data and other economic-activity indicators, we lowered our 1Q17 GDP (to be released next Thursday, June 1) to +1.1% qoq/sa (from: +1.4%). Our scenario assumes a strong contribution from agriculture and a favorable carryover for industrial production. Full Report
  • Macro Vision: Brazil less vulnerable to shocks. In this study, we highlight some of the buffers which have, in our view, indeed made the Brazilian economy less vulnerable to external shocks in recent years: i) high international reserves; ii) a reduced current account deficit, now fully covered by foreign direct investment; and iii) a lower stock of currency swaps, making room for BCB action. Full Report
  • In the roll over auction, the BCB placed the full offering of 8,000 FX swaps. After closing, the central bank called for a roll over auction of up to 8,000 contracts on May 29. 
  • The unemployment rate posted 3.5% in April – above our forecast and market expectations (both 3.3) – suggesting that the strength of labor market conditions might be beginning to wear off. April’s unemployment rate stood 3 p.p. below the level recorded in the same month of last year, in contrast with 1Q17 (when the average gap was 0.7 p.p., and labor market conditions looked tighter). In fact, the seasonally-adjusted unemployment rate reached a 10-year low in February (3.5%), and has increased to 3.6% in April. Nevertheless, formal employment (as per the data reported by the Mexican Institute of Social Security, IMSS) continued growing at a robust pace in April, above 4% year-over-year. Looking ahead, we expect the slowdown of gross fixed investment (hurt by tighter macro policies and the uncertainty on Nafta renegotiation) to have a negative impact in formal employment, and hence deteriorate labor market conditions. 
  • The central bank continued with the monetary easing cycle by cutting the policy rate by 25 bps, to 6.25%. The decision was in line with the majority of analysts but less than the 50-bp expected by us. The decision was the seventh consecutive split vote, with four co-directors falling in the majority, while the remaining three members preferred a 50-bp cut. This meeting marked the arrival of José Antonio Ocampo to the central bank, returning the board to its full representation of seven members for the first time since the January meeting this year. The press release announcing the decision does not vary significantly from last month. However, the removal of the reference to falling inflation expectations hints that the results from the central bank’s May survey, which showed an inflation expectation tick-up at all measured horizons following the April inflation upside surprise to the market, was a key factor behind the return to the more conservative approach. The central bank noted once again that recent data has increased the possibility of a wider output gap, although uncertainty over the amount of slack is elevated. Activity disappointed in 1Q17 (1.1% vs. 1.3% expected by the central bank’s technical staff), while recent industrial confidence dropped to its lowest April level since 2009. Meanwhile, consumer confidence has improved but is still near historical lows.
  • We expect the central bank to continue lowering the policy rate, but the pace of rate cuts (potentially including pauses) remains data dependent. We see the policy rate ending the year at 5.5% (75bps below the current level). Disappointing growth and declining headline inflation will be arguments for rate cuts, while the unfavorable behavior of core and non-tradable inflation measures will likely generate some caution. Full Report
Market Developments 
  • GLOBAL MARKETS: US 1Q17 GDP was revised up to 1.2% qoq/saar (from: 0.7%), above our call (0.8%) and market consensus (0.9%). The composition of the revision bodes well for the next quarters offsetting the downside surprise in the April Durables Goods report. So, our 2Q17 GDP tracking remained unchanged at +3.2%. Meanwhile, VIX remained hovering around 9.8 – the lowest since early 1990s. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities posted gains on the back of oil (WTI: +2.00% to USD 49.88/bbl). Meanwhile, metals posted losses (iron ore: -0.92%; copper: -1.21%). In LatAm FX, the currencies under our coverage were mixed. The MXN is trading 0.07% lower to 18.52/USD. The CLP depreciated 0.40% to 672.10/USD. The COP strengthened 0.27% to 2,910.93/USD. Finally, the BRL appreciated 0.46% to 3.2602/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm Credit spreads for the 5-year tenor were mixed in the session. Colombian spreads stood flat at 124bps. CDS in Chile widened 1bp to 71bps and in Mexico went up 2bps to 116bps. In Brazil, county risk went down 2bps to 239bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian yields narrowed on the back of short-term disinflationary shocks (see Macro Backdrop). In DI futures, the Jan-18 fell 20bps to 9.34% and the Jan-21 went down 27bps to 10.41%. For the Copom meeting next week (May 30-31), the curve implies almost 100bps in cuts, from 91bps as of Thursday (May 25). Brazil Rates Tracker
  • LOCAL RATES - Mexico: Short rates widened and long narrowed. In TIIE swaps, the 6-month went up 1bp to 7.42% and the 5-year went down 2bps to 7.42%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, long yields traded 1-2bps higher. In Camara swaps, while short rates stood flat (1-year: at 2.52%), long widened (5-year: +2bps to 3.55%). Chile Rates Tracker In Colombia, short rates widened ad long narrowed. In IBR Swaps, the 1-year went up 3bps to 5.24% while the 5-year went down 1bp to 5.32%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, all eyes will be on the Copom meeting (Wed.). We expect the central bank to deliver a 100-bp cut, thus maintaining the pace of the previous meeting, compared to previous expectations of a sharper cut. Then, this year’s first-quarter GDP figure will be the main highlight on economic activity (Thu.). We expect a 1.1% quarter-over-quarter seasonally adjusted increase, the first positive figure since 4Q14. In addition, April’s industrial production will be released (Fri.), for which we expect a flat figure, seasonally adjusted. Moreover, the nationwide unemployment rate for April will come out (Wed.). We expect a 0.1 p.p. increase to 13.3% (according to our seasonal adjustment). Also to be released are FGV’s industrial business confidence’s final reading for May (Mon.), ABRAS supermarket sales for April (Tue.) and FEBABRAVE’s vehicle sales for May (Thu.). On external accounts, we expect May’s trade balance (due Thu.) to once again post a strong surplus (USD 7.0 billion) in May, topping the surplus of USD 6.4 billion in May last year. 
  • In Mexico, the Ministry of Finance (Hacienda) will announce April’s fiscal balance (Mon.). We expect the fiscal deficit indicators to continue narrowing, as fiscal consolidation makes headway and oil revenues improve. Then, Banxico will publish the second Quarterly Inflation Report of the year (Wed.). We expect the central bank to increase its official GDP growth forecast for 2017 – currently 1.3%-2.3%. We also expect a more hawkish tone on inflation, in line with May’s monetary policy statement. Moreover, Banxico will publish the minutes of May’s monetary policy meeting (Thu.). We believe the minutes are likely to show more hawkish views on inflation, at least from some board members. Also, the Central Bank will publish May’s Economist Survey (Thu.). We expect an increase in both GDP growth and inflation expectations for 2017, given the upward surprises in the latest data. 
  • In Chile, the national statistics agency (INE) will publish the industrial activity indicators for the month of April (Tue.). We expect manufacturing production to have contracted 2.5% from last year (+1.9% in March). Then, INE will publish the national unemployment rate for the quarter ending in April (Wed.). We expect the labor market to continue loosening, with the unemployment rate ticking up to 6.8% (6.4% one year ago). Moreover, the central bank will publish the minutes from the May monetary policy meeting (Fri.). Given the weak economy and low inflation, we expect the minutes to shed some light on the circumstances that could lead the central bank to reopen the doors for rate cuts.  Finally, the national statistics agency (INE) will publish the private consumption activity indicators for April (Fri.). We expect the commercial activity index to have increased 1.0% from last year (+4.9% previously).
  • In Colombia, the national unemployment rate for the month of April will be released (Wed.). We expect the labor market to remain weak ahead amid low dynamism of the Colombian economy. Going forward, DANE will publish export data for April (Fri.). We expect exports to come in at USD 2.6 billion, representing annual growth of 7.9%, lifted by oil exports.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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