Itaú BBA - Oil rout pushes the COP above the 3,030/USD handle

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Oil rout pushes the COP above the 3,030/USD handle

June 20, 2017

The COP weakened 1.89% to 3,033.03/USD, as oil prices tested mid-November lows.

With information available until 6:30pm Brasilia time


  • Brent crude dropped further to 45.80/USD (-2.37%), testing the lows of mid-November (prior to Opec’s agreement). Accordingly, oil-exporters posted losses (COP: -1.89% to 3,033.03/USD; MXN: -1.29% to 18.19/USD), whereas the CLP depreciated only 0.37% to 663.95/USD. The BRL (-1.34% to 3.3274/USD) was additionally impacted by the rejection of the labor reform proposal in a Senate committee (see Macro Backdrop).
  • In rates, Brazilian yields opened under pressure from the external headwinds, and erased Monday’s gains after the labor reform proposal was rejected in a non-binding vote in the Upper House’s Social Affairs Committee. In DI futures, the Jan-18 rose 4bps to 8.92% and the Jan-21 widened 14bps to 10.13%.

Macro Backdrop

  • Macro Vision: What to expect for the 2Q17 Inflation Report. BCB is scheduled to publish its second Inflation Report (IR) for 2017 next Thursday. We believe the IR may signal the need to reduce the uncertainty and the scope of possibilities on the future course of monetary policy. Given the relatively advanced stage of the easing cycle, we expect the committee to keep signaling the possibility of a slowdown in the pace of easing to 75bps in July. Such signaling, however, will continue to be dependent on the data and the Copom's assessment of the impact of heightened uncertainty over the reform agenda in the prospective inflation trend. The communication can also be modified, reducing the emphasis on a possible moderation of the rate cut, due to new evidence on inflation (May’s IPCA surprised to the downside) and due to inflation expectations (despite greater political uncertainty, the median forecast in the Focus survey declined for 2017 and has remained relatively stable for 2018).
  • We estimate declines in the central bank’s forecasts for inflation in 2017 and relative stability for 2018. In the market scenario, the Focus exchange rate forecasts stand at 3.30/USD for 2017 and 3.40/USD for 2018. For the Selic rate, the Focus survey’s expectations are at 8.50% for both 2017 and 2018. We expect inflation forecasts to be at 3.6% for 2017 and 4.5% for 2018. In the hybrid scenario, with the Selic rate path as in the Focus survey and constant exchange rate, we expect inflation forecasts to be at 3.6% for 2017 and 4.4% for 2018.
  • We maintain our expectation that the Selic rate will end 2017 and 2018 at 8.00%. We forecast, for now, a slowdown in the pace of rate cuts to 75bps in July and to 50bps in the following three meetings (September, October, and December), recognizing that the pace can be changed depending on new evidence on inflation and on activity data. The risks to this forecast, in our view, seem to be symmetric. On the one hand, the output gap may be more disinflationary than we currently anticipate. On the other hand, the heightened uncertainty and difficulties in approving fiscal reforms may impact the equilibrium interest rate, leading to BRL depreciation, with potential inflationary implications. There is also a risk of tax hikes, given the government’s challenge to deliver the fiscal targets, which would also have an inflationary impact. Full Report
  • Tax collection came at BRL 97.7 billion in May, in line with our call (BRL 98.0 billion) and a touch below the market’s (at BRL 99.0 billion). Tax collection excluding tax amnesty programs (BRL 1.3 billion) decreased 1.9% y/y this month and is stable in the 3-month moving average. Taxes more linked to economic activity remain on a slow recovery trend, while other revenues (such as oil royalties) had a better performance.
  • Ahead, we believe tax collection growth will remain shy, especially considering the slower GDP growth with the more uncertain outlook for the approval of the pivotal Social Security Reform. As so, complying with the 2017 central government primary target of a BRL 139 billion deficit will likely prove to be challenging, barring significant extraordinary revenues surprises or further cuts in discretionary spending. We expect the central government primary result for the month of May (to be released next week) to register a BRL 20.3 billion deficit.
  • May’s formal job creation (Caged) came in at 34 thousand, between our estimate (+49k) and market expectations (+15k). On seasonally-adjusted terms, net job closings printed 19 thousand, improving the 3-month moving average to -43 thousand (-59 thousand previously). In all, job closings have been moderating. We expect unemployment to continue rising even as GDP recovers moderately, since the recent recession has not yet had a full impact on the labor market.
  • The labor reform was rejected in the Senate’s Social Affairs Committee by 10 votes against and 9 votes in favor. Nevertheless, the proposal is scheduled be read on the Upper House’s Constitution and Justice Committee (CCJ) on Wednesday (June 21).
  • BCB placed the full offering of 8,200 FX swaps. After closing, it announced another roll over auction of up to 8,200 contracts (USD 410 million) on June 21.
  • Next Thursday (June 22), Banxico decides on interest rates. In line with an almost unanimous consensus, we expect a 25-bp hike. In the minutes of the previous decision, two (out of five) board members mentioned the cycle was getting close to an end (which probably mean only one additional rate increase), while other two board members thought it was premature to stop hiking before inflation starts a downward trend. The fifth board member wasn’t present at the meeting, but there are strong reasons to believe he sides with the more dovish camp. Furthermore, in its recent inflation report the central bank stressed that the policy rate in real terms is close to the upper bound consistent with a neutral monetary policy, suggesting that at least the majority of the board is uncomfortable with much more tightening.
  • Still, we do not expect the central bank to close the doors for further tightening in the statement announcing this week’s decision. The fact that inflation remains high (and is becoming more wide-spread according to diffusion indexes) will likely prevent the central bank from pre-committing with a specific policy response.
  • Having said that, in our view only upside surprises on inflation (relative to the central bank’s own forecasts) can lead the Banxico to continue raising interest rates after this week’s meeting. After hiking by 375bps since December 2015, the central bank - or at least most of its members - do not see the Fed’s decisions as a key driver for its own policy moves anymore. Also, although the central bank hasn’t focused much on the evolution of exchange rate lately, it shouldn’t be forgotten that this was a key variable driving much of the hikes delivered by Banxico in this cycle and the Mexican Peso is currently trading at levels stronger than it was right before the U.S. Presidential elections. Finally, recent data has given more clear signals that the economy is slowing.
  • Aggregate supply (the sum of GDP and imports) expanded 4% year-over-year in 1Q17, closer to our forecast (4.1%) than to median market expectations (3.1%). Adjusting for calendar effects, aggregate supply also expanded 4% year-over-year (4Q16: 1.9%), driven by firm GDP growth (2.6% year-over-year) and a rebound of imports of goods & services (8.6% year-over-year) which could be explained by the MXN appreciation during the quarter. Looking at working-day adjusted data, domestic demand expanded 1.8% year-over-year (4Q16: 2.1%). The robust 3.3% year-over-year growth of private consumption (4Q16: 2.8%) prevented a sharper slowdown, whereas both public (-11.2% year-over-year, -6% previously) and private investment (-0.7% year-over-year, 2.4% previously) dragged domestic demand. The former’s sharp decline is attributable to the fiscal consolidation, while the latter seems to be related to the uncertainty surrounding the Nafta renegotiation. On the bright side, external demand looks increasingly stronger: exports of goods & services grew at a strong 7.6% year-over-year (4Q16: 1.8%). Finally, the contribution of inventories to growth in 1Q17 was nil.
  • Looking ahead, we expect growth to slow down to 2% in 2017, from 2.3% in 2016, with stronger exports falling short to offset the deterioration of domestic demand. In fact, currently there are a number of headwinds affecting domestic demand, such as: uncertainty surrounding trade relations with the U.S. (discouraging investments), higher inflation (affecting real wages), and tighter macro policies (in the form of rising rates and fiscal cuts). We note that the deterioration of investment is preceding the slowdown of consumption, but we believe the latter will follow suit in coming quarters. Conversely, solid growth in the U.S. will likely continue to act as a buffer by boosting Mexico’s manufacturing exports. Full Report


  • The trade deficit came in at USD 1.2 billion in April, larger than the USD 1.0 billion market consensus (also our forecast). As a result, the deficit is larger than the USD 1.1 billion recorded one year ago. This led to a rolling 12-month trade deficit of USD 10.2 billion (USD 10.0 billion as of March), still down from USD 11.5 billion in 2016 and USD 15.6 billion in 2015. The recent widening is explained by a faster rise in the non-energy balance deficit compared to the increase in the energy balance surplus. At the margin, the trade deficit also widened as capital imports accelerated, while exports contracted. The annualized trade deficit (using our seasonal adjustment) increased to USD 11.1 billion in the quarter ending in April, from the USD 8.9 billion deficit in 1Q17 (USD 7.8 billion deficit for 4Q16). We expect a current account deficit of 3.6% of GDP this year (4.3% last year), aided by higher terms-of-trade and weak internal demand. However, if the recent fall of oil prices persists, the risk is for a wider current account deficit (relative to our forecast). Full Report
Market Developments
  • GLOBAL MARKETS: Volatility gauges rose and major equity indices were on the red, as risk aversion increased in global markets. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Brent crude dropped further to 45.80/USD (-2.37%), testing the lows of mid-November (prior to Opec’s agreement). Accordingly, commodity-FX weakened 1.30% in average terms, while the broad EMFX index fell -0.71%. Within LatAm, oil-exporters were the laggards (COP: -1.89% to 3,033.03/USD; MXN: -1.29% to 18.19/USD), whereas the CLP depreciated only 0.37% to 663.95/USD. The BRL (-1.34% to 3.3274/USD) was additionally impacted by the rejection of the labor reform proposal in a Senate committee (see Macro Backdrop). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads (5-year) widened all across LatAm. Brazil and Colombia increased 4bps to 242bps and 135bps, respectively. Mexican risk premium rose less steeply (+2bps to 113bps), whereas Chile stood flat at 69bps again. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian yields opened under pressure from the external headwinds, and erased Monday’s gains after the labor reform proposal was rejected in a non-binding vote in the Senate’s Social Affairs Committee. In DI futures, the Jan-18 rose 4bps to 8.92% and the Jan-21 widened 14bps to 10.13%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican yields widened once more, tracking the MXN’s sell-off. In TIIE swaps, the 1-year and the 10-year rose 4bps to 7.41% and 7.26%. Breakevens inched up 1bp across the curve (5y5y: +2bps to 3.76%). Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: Long Chilean rates went south, in contrast to the other LatAm curves. In Camara swaps, the 10-year edged down 1bp to 3.40%. Chile Rates Tracker The Colombian curve shifted higher, as 5-year IBR swaps jumped 12bps to 5.35%. The curve prices-in 100bps (filtering out the term premium) in rate cuts for the remainder of the year.Colombia Rates Tracker

Upcoming Events

  • In Brazil, the Central Bank’s Quarterly Inflation Report (QIR) for Q2 will be released (Thu.). Moreover, June’s IPCA-15 consumer inflation preview will be released (Fri.). 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. Then, FGV’s industrial business confidence preview for June will be released (Thu.). Finally, CNI will release its industrial business confidence for June (Thu.).
  • In Mexico, the statistics institute (INEGI) will publish CPI inflation figures for the first half of June (Thu.). We expect bi-weekly inflation to come in at 0.15%. June usually features a seasonal decrease of agricultural prices, but price surveys reported by the Ministry of Economy indicate that agricultural prices increased during the first half of June. Assuming our forecast is correct, annual inflation would increase to 6.30% year-over-year (from 6.16% in the second half of May). Moreover, the Central Bank’s board will meet to decide on the reference rate (Thu.). We expect Banxico to deliver a 25-bp hike, taking the reference rate to 7%, in lockstep with the U.S. Fed. Finally, INEGI will announce the growth rate of April’s retail sales (Fri.), which we forecast at 1.5% year-over-year (down from 6.1% in March).
  • In Colombia, activity indicators are the on the market's radar. The April activity coincident indicator (ISE) will be published (Thu.). The March index declined 0.9% year over year. Also, local think-tank Fedesarrollo will publish the May industrial and retail confidence indicators (Thu.). In April, the components of business confidence continued to deteriorate. Weak confidence suggests a solid recovery of Colombia’s economy is unlikely in the near term.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza

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