Itaú BBA - The Brazilian curve flattens as BCB signals slower easing ahead

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The Brazilian curve flattens as BCB signals slower easing ahead

June 1, 2017

In DI futures, the Jan-18 widened 14bps to 9.39% and the Jan-25 went up 8bps to 11.04%.

With information available until 6:30pm Brasilia time


  • After the Copom, the Brazilian curve bear flattened (Jan19x25: -12bps). In DI futures, the Jan-18 widened 14bps to 9.39% and the Jan-25 went up 8bps to 11.04%. For the next Copom meeting (25-26 July), the curve implies roughly 67bps in rate cuts from 75bps as of Wednesday (May 31). 
  • In LatAm FX, currencies were mixed. The COP outperformed its regional peers, closing at 2,893.34/USD (+0.79%). The MXN is 0.13% weaker to 18.64/USD). The CLP (+0.06% to 672.17/USD) remained broadly stable. At last, the BRL depreciated 0.70% to 3.2499/USD. 

Macro Backdrop

  • Copom: no surprise for now, slower easing later. In the statement, the Committee assesses that data released since last meeting are consistent with a stabilization of the economy in the short run, followed by a gradual recovery during the year. The Copom reckons that prolonged, elevated, uncertainty on the reform process and on economic adjustment (which probably refers to fiscal policy) may have negative implications for economic activity. The committee stresses that the increase in uncertainty on the reform and adjustment process is the main risk to the forward looking scenario, with effects on the determinants of inflation that are not trivial to assess – but whose net impact is, judging from the overall tone of the document, probably inflationary in their view. Considering this baseline scenario, the balance of risks and other information, the committee decided to cut the Selic by 100bps, with a view towards affecting inflation in 2017 and, predominantly, 2018.
  • The text also repeats that the cycle’s extension will depend on estimates about the "structural interest rate" of the Brazilian economy, which will be reassessed by the Copom over time. The committee stresses that the recent increase in uncertainty about the reforms and adjustments hinders a faster reduction of estimates of the structural interest rate and turns this, too, more uncertain. Given the basic scenario and the current balance of risks, the Copom reckons that a “moderate reduction in the pace of easing”, which we read to mean a cut of 75bps, should be adequate in the next policy meeting, with the usual caveats that the actual decision will depend on a number of issues, including the behavior of economic activity, the balance of risks, possible reassessments of the overall magnitude of the cycle, inflation expectations and forecasts. We'll learn more about the reasoning behind the Copom decision with the release of the minutes on Tuesday (June 6). Full Report
  • GDP increases 1.0% in 1Q17. The figure came in line with our estimate and the median of market expectations (1.1% and 1.0%, respectively) and is the first quarterly gain after eight consecutive quarters of contraction in economic activity. Compared to 1Q16, GDP shrank 0.4%. Hence, the change accumulated over four quarters improved to -2.3% (from -3.6% in 4Q16). From the demand standpoint, domestic components showed weakness. Gross fixed capital formation retreated 1.6% qoq/sa, while household spending slid 0.1% qoq/sa. Hence, the quarterly result was positive mainly due to a substantial contribution from inventories and stronger net exports. On the supply side, agriculture climbed 13.4% and the industrial sector expanded 0.9% during the period, while the service sector was stable at the margin after eight consecutive quarters of declines.
  • Notwithstanding a robust gain in 1Q17, economic activity growth in 2Q17 should be lower, and we see risks of a negative figure. The main reason is the reversion of the two factors that contributed to the increase in GDP in 1Q17: agricultural GDP will likely provide a mildly negative contribution and the statistical carryover from industrial production will be negative as the indicator fell heavily in March. Additionally, coincident indicators suggest stagnated activity in April and May. Economic fundamentals are improving, particularly interest rates, paving the way for a broad-based recovery going forward. However, in order for the recovery to be solid, the reform agenda must continue to advance. In such context, heightened uncertainties recently regarding the approval of reforms may affect activity through two channels. Firstly, by making companies and consumers more cautious, weakening aggregate demand and increasing risks of another round of contraction. Secondly, by reducing the pace of monetary easing. Full Report
  • Falling commodity prices hurt exports in May. Over 12 months, the trade surplus increased again to USD 57.1 billion. The seasonally-adjusted annualized three month moving average declined to USD 78 billion, just slightly offsetting the strong performance of the earlier months. The year-to-date trade surplus is the highest in the historical series started in 1992. Exports increased 7.5% yoy, adjusting for the number of working days. Growth was again led by sales of basic items (11.6% yoy), which climbed for a fifth consecutive month, while sales of manufactured goods also advanced (16.4% yoy). On a seasonally adjusted monthly basis, though, exports fell 9.1%, erasing some of the strong gains of recent months. Meanwhile, imports advanced for the sixth consecutive month in year-over-year terms, by 4.0%, led by intermediate goods (1.5% yoy), consumer goods (20.2% yoy), and fuels and lubricants (30.2% yoy). However, on a seasonally-adjusted monthly basis, total imports decreased for the fourth consecutive month, by 2.6%, dragged by lower purchases of capital goods (-8.8% mom/sa), intermediate goods (-6.6% mom/sa), and fuels and lubricants (-9.6% mom/sa).
  • May figures show some moderation in the trade balance, at the margin. Exports of basic goods, which advanced sharply earlier in the year, fell during the month, in line with the recent decline in international commodity prices. Nevertheless, imports remain at low levels, ensuring strong trade surpluses. We maintain our expectation of a large trade surplus this year (as in 2016), supported by the strong results achieved in the first five months of 2017. Full Report
  • According to Fenabrave, vehicle sales reached 190 thousand in May, rising 1.1% mom s.a. and up for the fourth month in a row. Despite the material improvement since 4Q16, vehicle sales remain at low levels if compared to 2011-2015 levels. The breakdown shows a 1.1% increase in “passenger cars + light vehicles” and 1.4% increase in “trucks + buses”, according to our seasonal adjustment. Our forecast for auto production (Anfavea), to be released next Tuesday (June 6), is 236 thousand in May.
  • The central bank published the minutes of May’s monetary policy meeting, in which the Board decided to increase the policy rate by 25bps (to 6.75%), in line with our call and surprising market expectations. The minutes are clear-cut about the reasons that led Banxico to hike rates in May, as the document explicitly reads that all board members decided to vote for tightening monetary policy with the purpose of “preventing contagion in the price formation process and anchoring inflation expectations” (in other words, avoid second-round effects). Likewise, all board members agreed that the balance of risks on inflation has deteriorated. Moreover, the “majority” acknowledged that the share of items in the CPI basket with inflation above 4% has continued increasing, although only “some” (that means 2 out of the 5 board me members) argued that the inflation correlation across items has increased and the risk of second-round effects has intensified. Interestingly, the minutes also show that the majority of the board considers that the exchange pass-through to domestic prices is now higher (something that was previously described as a risk, but now seems to be taken as a fact). So, bottom-line, May’s hike was largely about deteriorated inflation conditions. 
  • We expect Banxico to deliver two more 25-bp hikes in 2017 (with the next one in June, in lockstep with the Fed). Assuming that inflation begins trending down in 4Q16 and activity deteriorates more visibly from 2Q17 onwards, our call is that Banxico will end the tightening cycle. There are balanced risks for our call: while the fact that some board members see the cycle ending soon increases the probability of only one additional 25-bp rate hike, the behavior of inflation may end up forcing the central bank to raise interest rates by a bit more than we are currently expecting. Full Report
  • According to Adimark’s May public opinion survey, Sebastian Piñera continues to hold a narrow lead over nearest competitor Alejandro Guillier, while distant challenger Beatriz Sanchez failed to build on the gains made in the previous month. Overall, Piñera’s lead over Guillier edged down to 4 percentage points (from 5% in April). Piñera holds 25% of voting intentions (24% in April), Guillier picked up two points to 21%, while Sanchez was stable at 11%. In spite of not gaining ground in the voting intentions, Sebastian Piñera is now viewed by 55% of respondents as the likely successor to Michelle Bachelet, up 5 percentage points from April. Meanwhile, only 21% believe Guillier will have a successful campaign (23% previously). Important to note is undecided voters dropped to 26%, from 29% in the previous two months. Nevertheless, the undecided vote remains significant and means a high level of uncertainty persists in the lead up to the November 19 election. As is generally the case in the final year of an administration, approval of President Bachelet continues to improve (up to 31% from 28% in April and the 19% low in August last year). 
  • Widespread improvement in activity surprises. Our Itaú Activity Surprise Index rose to 0.22 in May from 0.10 in April, led by improvements all across LatAm. In Brazil, better-than-expected job market figures compensated disappointing industrial production and retail sales. Chile’s activity releases painted a brighter picture in May, but a meaningful recovery is not on the near horizon. Peru registered the most expressive improvement in the region, as weather-related supply disruptions subsided over the past month. Full Report
Market Developments 
  • GLOBAL MARKETS: Ahead of payrolls, US dollar strengthened vis-à-vis G10 (+0.31%) after solid leading indicators. Private payrolls came in stronger than expected, beating the most optimistic estimate. Also, ISM manufacturing came in a bit above expectations amid better New Orders (to 59.5 from 57.5) and contained Inventories (to 51.5 from 51.0). US treasuries widened at the margin (5-year: +1bp to 7.76%). Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities traded lower in the session as oil prices weakened (WTI: -0.75% to USD 47.96/bbl). Additionally, iron ore (-0.69%) and soybean (-0.41%) posted losses. In LatAm FX, currencies were mixed. The COP outperformed its regional peers, closing at 2,893.34/USD (+0.79%). The MXN is 0.13% weaker to 18.64/USD). The CLP (+0.06% to 672.17/USD) remained broadly stable. At last, the BRL depreciated 0.70% to 3.2499/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm Credit spreads for the 5-year tenor traded range bound in the session. Brazilian, Chilean and Mexican spreads stood flat at 236bps, 70bps and 119bps, respectively. Country risk in Colombia, however, inched down 1bp to 127bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: After the Copom, the Brazilian curve bear flattened (Jan19x25: -12bps). In DI futures, the Jan-18 widened 14bps to 9.39% and the Jan-25 went up 8bps to 11.04%. For the next Copom meeting (25-26 July), the curve implies roughly 67bps in rate cuts from 75bps as of Wednesday (May 31). Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican yields narrowed in the session. In TIIE swaps, the 1-year went up 5bps to 7.51% and the 10-year increased 6bps to 7.55%. Likewise, real rates narrowed as the Jun-19 fell 3bps to 3.12%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, rates narrowed as well. In Camara swaps, while the 1-year fell 1bp to 2.45%, the 5-year went down 5bps to 3.40%. Chile Rates Tracker In Colombia, yields were mixed in the session. In IBR swaps, while short rates widened at the margin (9-month: +1bp to 5.31%), long narrowed (5-year: -6bps to 5.24%). Colombia Rates Tracker

Friday Events

  • In Brazil, April’s industrial production will be released. We expect a flat figure (seasonally adjusted) and on year-over-year terms a 5.7% fall. 
  • In Chile, the central bank will publish the minutes from the May monetary policy meeting. 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. We expect the commercial activity index to have increased 1.0% from last year (+4.9% previously).
  • In Colombia, DANE will publish export data for April. 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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