Itaú BBA - S&P places Brazil on CreditWatch negative

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S&P places Brazil on CreditWatch negative

May 23, 2017

On Monday (May 22), S&P placed Brazil’s sovereign ‘BB’ long-term foreign and local currency credit ratings on CreditWatch with negative implications.

With information available until 6:30pm Brasilia time


  • On Monday (May 22), S&P placed Brazil’s sovereign ‘BB’ long-term foreign and local currency credit ratings on CreditWatch with negative implications. The agency cited an “increased risk that a disruptive or slow resolution of recent political developments could delay and undermine the ability of Brazil’s political class to advance corrective policy measures in a timely fashion – in this instance, ahead of the 2018 presidential and legislative elections – while its economic and fiscal challenges continue to mount”.
  • In rates, the Brazilian curve bull flattened. In DI futures, the Jan-18 fell 15bps to 9.60% and the Jan-19 went down 33bps to 9.90%. Real rates also narrowed substantially as the Aug-24 fell 18bps to 5.68%. The BRL (-0.11% to 3.2702/USD) remained volatile amid political uncertainty. 
  • Elsewhere in LatAm FX, currencies under our coverage were mixed. Andean pairs posted losses as the COP fell 0.11% to 2,908.63/USD and the CLP depreciated 0.57% to 674.25/USD. Yet, the MXN is trading 0.15% higher to 18.63/USD. 

Macro Backdrop

  • The IPCA-15 result in May (0.24%) printed slightly above our estimate and the median of market expectations (both at 0.20%). The index had climbed 0.21% in the previous month and 0.86% in May 2016. Hence, the IPCA-15 is up by 1.46% year-to-date (down from 4.21% in the year-earlier period), while the year-over-year change decelerated to 3.77% from 4.41% in April. According to census bureau IBGE, it was the lowest year-over-year change since July 2007. Breaking down by product groups, the largest upward contributions during the month came from food and beverages (0.11 p.p.), and healthcare and personal care (0.10 p.p.). On the other hand, the transportation group posted a negative change (-0.07 p.p.) for a third consecutive month. In that case, the largest downward contributions came from fuels (-0.06 p.p.) and airfares (-0.04 p.p.). The diffusion index (which measures the share of products with positive price changes) stood at 56.4%, virtually unchanged from 56.7% in April. Seasonally-adjusted total diffusion widened to 56% from 54%. 
  • Based on the IPCA-15 report and other current information, we maintain our forecast for the headline IPCA in May at 0.50%, with the year-over-year change slowing down to 3.8% (previous: 4.1%). In our view, the largest upward contribution will come from housing (0.35 p.p.), driven by electricity (0.30 p.p.), due to the reversal of the effect related to a nuclear power plant, which had caused a temporary decline in electricity bills in the previous month. The healthcare and personal care is set to provide a contribution of 0.10 p.p., still reflecting adjustments in medication prices and health insurance premiums. On the other end, we expect transportation and food to give negative contributions in May. Full Report
  • The current account surplus totaled USD 1.2 billion in April, slightly above our estimate (USD 950 million surplus), and in line with market consensus. The reading was better than the USD 412 million surplus recorded in April 2016. Over 12 months, the current account deficit receded to USD 19.9 billion or 1.1% of GDP. The seasonally-adjusted annualized three-month moving average points to a USD 1.2 billion surplus in April (previous: USD 8 billion deficit). The biggest positive contribution came again from the trade balance, with a USD 6.7 billion surplus, way up from USD 4.6 billion in April 2016. The strong trade surplus has helped to maintain low current account deficits. We still expect large trade surpluses this year, but a rebound in domestic demand and lower commodity prices (from current levels) tend to produce slightly weaker readings in the next months. Thus, the current account deficit is set to widen from current levels throughout the year.
  • In the financial account, direct investment in the country (DIC) added up to USD 5.6 billion, in line with our estimate and market consensus (both at USD 5.5 billion). Equity capital transactions accounted for USD 6.9 billion of total DIC, but intercompany loans resulted in USD 1.4 billion outflows, as debt amortizations topped credits received from abroad. DIC accumulated over 12 months remained around USD 85 billion. Preliminary data published by the Central Bank show thinner DIC inflows in May (USD 1.4 billion as of May 19). After two consecutive months of outflows, foreign investment in the local capital markets was positive by USD 3.6 billion, as USD 4.4 billion inflows to fixed income outsized USD 774 million outflows from the stock market. However, over 12 months, foreign investment in the local capital markets remains negative, by USD 11.4 billion. Preliminary data released by the Central Bank show small inflows into stocks (USD 184 million) and outflows from the local fixed income market (USD -2.5 billion) as of May 19. In all, DIC remains elevated, reducing Brazil’s reliance on volatile capital flows. Full Report
  • The government reduced the budget freeze by BRL 3 billion. The government published its bi-monthly report with estimates for 2017 primary revenues and expenditures in order to comply with the 139 billion deficit target (or -2.2% of GDP). Recurrent tax revenues were reduced by BRL 4 billion while revenues not directly related to economic activity were increased by BRL 12 billion. Mandatory spending was increased by BRL 4 billion, amid a revision of the estimate of the partial end of the payroll exemption, but also increases in the annual bonus and unemployment insurance estimates. The revisions led to a reduction of BRL 3 billion in the budget freeze announced in March. Hence, the 2017 budget freeze now totals BRL 39 billion from BRL 42 billion in March.
  • In all, complying with the 2017 target remains a feasible, but also challenging task. The main risk continues to be another round of disappointments in economic activity and tax collection, especially considering the more uncertain outlook for the approval of the Social Security reform. Also, the government counts with BRL 55 billion in non-recurrent measures to deliver the target. While this agenda is a constant risk to this year’s revenues, the estimate could rise by around BRL 10 billion in the next revision, mostly coming from judicial deposit withdraws.
  • In the roll over auction, the BCB placed the full offering of 8,000 FX swaps announced on Monday (May 22). After closing, the central bank called for a roll over auction of up to 8,000 contracts on May 24. 
  • In the third extraordinary auction, the central bank placed 2,530 contracts (USD 126.5 million) due in August 2017. For the October 2017, were placed 16,030 contracts (USD 801.5 million). For the January 2018, were sold 21,440 contracts (USD 1,072 million). According to the note published on Thursday (May 18), this was the third and last auction of the same size.
  • Retail sales weakened in 1Q17, in contrast with the broader services sector which remained robust. Retail sales expanded 6.1% year-over-year in March – above our forecast (5%) and market expectations (5.5%) – favored by a positive calendar effect (2 extra business days compared to March 2016) which added 2.1 p.p. to growth. In fact, calendar-adjusted data shows that retail sales expanded 3.4% year-over-year in March, leaving the growth rate of 1Q17 at 5.3% year-over-year (4Q16: 9.9%). Granted, the spike of gasoline prices and the looting of retail stores affected the performance of retail sales in 1Q17. Actually, excluding fuels, oils & lubricants from the retail sales index, growth was 5.8% year-over-year in 1Q17 (which means that the “gasolinazo” had a first-order impact of 0.5 p.p.). The slowdown is more visible at the margin, with deteriorating momentum. Seasonally-adjusted retail sales fell 1.3% from the previous month, showing a quarter-over-quarter annualized contraction (-2.2% in 1Q17, from 6.7% qoq/saar in 4Q16) for the first time in four years.
  • We expect a further slowdown of retail sales in coming quarters. The solid performances of the broader services sector (4.1% qoq/saar in 1Q17) and the monthly private consumption indicator (6.4% qoq/saar in February) show that consumption remained resilient to the shocks, at least until 1Q17. Within the services sector, we note that financial & insurance, entertainment and professional services were particularly robust. However, in our view, the deterioration of fundamentals will likely be more visible in the consumption data in coming quarters. Annual inflation jumped to 5.8% in April (March: 5.4%) and it has yet to peak (around 6.1% in August, according to our baseline scenario). The strength of formal employment has not been enough to offset the increase of inflation, so the real wage bill has been slowing down. Moreover, the labor market has to give in at some point. We believe formal employment creation will eventually weaken as investment slows down (dragged by fiscal consolidation, higher domestic interest rates, and the uncertainty surrounding bilateral relations with the US which puts investment decisions on hold). Full Report
Market Developments 
  • GLOBAL MARKETS: Ahead of the FOMC minutes, US Treasuries widened (5-year: +3bps to 1.83%). Equity markets were on the green while VIX is back hovering at historically low levels. The Fed funds implied probability of a rate hike in June stood at 100% as of Monday (May 22). Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities were mixed in the session. Oil prices continues to rise (WTI: +0.70% to USD 51.49/bbl) amid widespread expectations that the Opec and the major producers would agree to continue reining in output. On the other hand, iron ore prices fell 2.60% and soybean decreased 0.86%. In LatAm FX, currencies under our coverage were mixed. Andean pairs posted losses as the COP fell 0.11% to 2,908.63/USD and the CLP depreciated 0.57% to 674.25/USD. Yet, the MXN is trading 0.15% higher to 18.63/USD. At last, the BRL (-0.11% to 3.2702/USD) remained volatile amid political uncertainty. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads for the 5-year tenor narrowed all across LatAm. Chilean spreads decreased 1bp to 70bps. CDS in Colombia and Mexico both also fell 1bp to 125bps and 114bps, respectively. Country risk in Brazil went down 5bps to 244bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bull flattened in the session. In DI futures, the Jan-18 fell 15bps to 9.60% and the Jan-19 went down 33bps to 9.90%. Real rates also narrowed substantially as the Aug-24 fell 18bps to 5.68%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican rates widened across the curve, tracking US Treasuries. In TIIE swaps, the 1-year increased 4bps to 7.54% and the 5-year went up 11bps to 7.45%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields traded range bound. In Camara swaps, the 1-yeat inched down 1bp to 2.54% and the 7-year stood flat at 3.51%. Chile Rates Tracker In Colombia, short rates narrowed in the session. In IBR Swaps, the 1-year went down 6bps to 5.21% while the 5-year stood broadly flat at 5.33%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, April’s tax collection may be released throughout the week. We forecast BRL 114.6 billion in tax collections, or a decline of 0.7% year-over-year in real terms. Then, the consolidated primary budget balance for April will come through (Fri.). We expect a BRL 9.0 billion surplus, with the central government result (due Thur.) posting a BRL 8.2  billion surplus and regional governments and state-owned companies’ result amounting to a BRL 2.0 billion surplus (they don’t add up due to a discrepancy between the Treasury’s and the Central Bank’s expenditure accounting). Also to be released are confidence indicators (FGV) for consumers (Wed.), retail (Thu.) and construction (Fri.). 
  • In Mexico, the statistics institute (INEGI) will publish CPI inflation figures for the first half of May (Wed.). We expect bi-weekly inflation to post -0.42%, explained by the decrease of electricity tariffs announced by the Federal Electricity Commission (CFE), a decrease of gasoline prices, and a drop of agricultural prices (which spiked in April). Assuming our forecast is correct, headline inflation would increase to 6.08% year-over-year (from 6.01% in the second half of April). Following, INEGI will announce April’s trade balance (Thu.), which we expect to come in at USD -1,500 million. We expect the trade deficit to continue narrowing at the margin, driven by an improvement in the non-energy balance which is explained by firmer manufacturing exports (boosted by stronger industrial output in the U.S. and a competitive real exchange rate). Shortly after, the Central Bank will publish Q1’s current account balance (Thu.). We expect the current account deficit at USD 6,795 million in 1Q17, with the 4-quarter rolling deficit narrowing to USD 25.8 billion (2.5% of GDP, according to our calculations) from USD 27.9 billion (2.7% of GDP) in 4Q16. Finally, INEGI will announce April’s unemployment rate (Fri.). We expect the unemployment rate to post 3.3% (below the 3.8% rate recorded in the same month of last year) given that labor market conditions remain tight. 
  • In Colombia, local think-tank Fedesarrollo will publish the April industrial and retail confidence indicators (Wed.). With the economy continuing to show signs of weakness, we expect confidence levels to remain at low levels. Then, the central bank hosts its monthly monetary policy meeting (Fri.). Last month, a split board surprised the majority of the market by cutting the policy rate by 50bps to 6.50%. We believe that the increased concern with activity will likely lead a majority of the board to favor a second consecutive 50-bp cut to 6.00%.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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