Itaú BBA - The BRL sells off as the market sees risks to the fiscal reform

Latam FI Strategy Daily

< Back

The BRL sells off as the market sees risks to the fiscal reform

March 23, 2017

In rates, Brazilian bond yields increased in the session on concerns over an inflationary effect of a possible tax increase next week.

With information available until 6:30pm Brasilia time

Highlights

  • The BRL was the bottom performer in EMFX due to concerns over the Social Security reform, closing at 3.1407/USD (-1.68%). In rates, Brazilian bond yields increased in the session on concerns over an inflationary effect of a possible tax increase next week. The LTN auction (Apr-18, Apr-19, Jul-20) also contributed in pushing rates upwards. In LTN, the Jan-18 increased 7bps to 9.97%. 
  • In Mexico, the TIIE swaps curve bull flattened on remarks made by Banxico’s Carstens: “we feel inflation is progressing as it should progress given the shock we face”. In TIIE swaps, the 10-year decreased 8bps to 7.49%. the MXN appreciated 0.43% to 18.95/USD – hitting the 18.9/USD handle for the first time since November. 

Macro Backdrop

BRAZIL
  • February’s industrial business confidence preview (FGV) points to a 3.3% m/m increase. The data came in higher than our +2.5% forecast. Also, Industrial capacity utilization indicates a rise of 0.3 p.p., and continues stable and below the historical average. We expect business confidence to follow an upward trend in the coming months. The definitive numbers will be published Wednesday (Mar-29).
  • The government announced a fiscal gap of BRL 58 billion to meet the 2017 primary fiscal target of a deficit of BRL 139 billion. A new announcement on Tuesday (March 28) will detail the specific measures and numbers, but the government already revealed that the budget cut will be lower than BRL 58 billion, depending on decisions made by the Superior Court of Justice over the next days, as well as the magnitude of tax increases (the most talked about in the news being PIS/COFINS on fuels and the ending of payroll tax exemptions).
  • The Lower House voted in favor of the outsourcing bill (PL 4302/1998), which regulates and allows for the outsourcing of all activities by businesses. The legislation, from 1998, allows for unrestricted outsourcing, including in end-tasks, presently prohibited. Furthermore, the bill extends the period of contracts for temporary work from three months to nine months.
  • BCB placed the full offering of 10,000 FX swaps. After closing, the Central Bank called a roll over auction of up to 10,000 contracts on March 24.
MEXICO
  • Inflation came in high in the first half of March. Mexico’s CPI posted a 0.35% bi-weekly variation - above our forecast (0.25%) and slightly above market expectations (0.33%) - driven by the lagged effects of exchange rate depreciation and a rebound of agricultural prices, partly offset by a decrease of gasoline prices. Core goods (proxy for tradables) increased by 0.44%, adding 15bps to bi-weekly inflation, while agricultural prices rose 1.4% (after falling for the past two months), which added another 13-bps. These increases, however, were cushioned by a decline of gasoline and mobile telephone service prices. Overall, CPI inflation has consistently exceeded its 5-year median in 2017 (doubling it in the first half of March). Annual headline inflation increased to 5.29% y/y (previous: 5.02%) further above the Central Bank’s target. Core inflation stood broadly unchanged at 4.32% (previous: 4.31%) as the consistent increase of core goods inflation (5.74%, previous: 5.52%) - which responds to the lagged effects of peso depreciation - was offset by a decrease in core services (3.13%, previous: 3.29%).
  • We expect inflation to peak around 3Q17 (at 5.4%) and then decrease to 5% by the end of the year, driven by the weakening of domestic demand and the stabilization of the peso. The Mexican peso has appreciated in 2017, supported by the perception of lower protectionism risk and Central Bank intervention. So this could help to contain the pressure on tradable prices and reduce inflation expectations. The weakening of internal demand (partly due to tighter macro policies) will also help to bring inflation down. Full Report

CHILE

  • As talks between Escodida mine union and the operator of the firm fail, workers said they would invoke an article of the current labor law which effectively extends the existing collective contract for 18 months. This means workers will forgo the end-of-conflict bonus initially demanded (just below USD 40 thousand  per worker) or the one offered by the firm (some USD 16 thousand), as well as any wage increase. The union leaders claim this is not a loss for workers, as the negotiation a year and a half from now would occur under the new labor law (to become effective as of April 1), meaning the union would be on a better footing to negotiate with the mine's administration. None-the-less, the 43-day long strike at the largest copper mine in Chile (contributing with 20% of copper output) will likely hurt growth figures for February and March, leading to a negative year-over-year growth rate for 1Q17 (we estimate growth could be as low as -0.5% y/y). As production recovers in coming months, activity would regain dynamism and favor a pick-up in growth. We expect GDP to expand 1.8% this year, after the 1.6% recorded last year.

COLOMBIA

  • In February, the components of business confidence deteriorated from one year ago. According to think-tank Fedesarrollo, industrial confidence came in at -0.1% in February (0 is neutral), below the 10.4% recorded one year earlier and registering the lowest February level since 2013. Seasonally adjusted, industrial confidence fell nearly 5% from the previous month, moving further into negative territory. This is consistent with the weak activity as the economy undergoes the adjustment to the terms-of-trade shock. Compared to the same month last year, all the industrial confidence components deteriorated. In particular, the volume of goods ordered component worsened to -25.1% (from -8.8%), possibly reflecting the deteriorating current situation. Meanwhile the quarterly construction survey undertaken showed that there is an optimistic outlook for construction performance in the coming quarter. On the other hand, retail confidence remained optimistic at 23.2%, but still worsened from the 25.4% one year prior. However, the still favorable outlook from retailers is in sharp disparity with the historically low levels reached by consumer confidence. With the economy continuing to show signs of weakness, we expect confidence levels to remain at low levels.

Market Developments 

  • GLOBAL MARKETS: European equities outperformed as Le Pen slipped in the polls after the first French presidential debate: Macron's (26%) and Fillon's (14%) margin in the second round over her both have risen. US treasuries traded range bound as market awaits for the Healthcare bill to be voted in the Lower House. The White House expects the vote to take place Friday morning. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities traded lower and oil prices dropped (Brent: -0.26% to USD 50.51/bbl). In LatAm FX, currencies under our coverage were mixed. Andean currencies traded range bound (CLP: -0.06% to 663.22/USD; COP: +0.10% to 2,918.43/USD) while the MXN appreciated 0.43% to 18.95/USD – hitting the 18.9/USD-handle for the first time since November. The BRL was the bottom performer in EMFX due to concerns over the Social Security reform, closing at 3.1407/USD (-1.68%). FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm credit spreads for the 5-year tenor decreased, except for Brazil. Chilean spreads inched down to 77bps (-2bps). Mexican and Colombian country risk fell 3bps to 140bps and 4bps to 142bps, respectively. However, Brazil CDS increased 2bps, to 241bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian yields on bonds increased in the session on concerns over an inflationary effect of a possible tax increase next week. The LTN auction (Apr-18, Apr-19, Jul-20) also contributed in pushing rates upwards. In LTN, the Jan-18 increased 7bps to 9.97% and the Jan-19 went up 4bps to 9.58%. Accordingly, NTN-Bs widened (Aug-22: +3bps to 5.30%). Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve bull flattened again on remarks made by Banxico’s Carstens: “we feel inflation is progressing as it should progress given the shock we face”. In TIIE swaps, the 1-year fell 2bps to 7.09% and the 10-year decreased 8bps to 7.49%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields traded marginally lower. In Camara swaps, the 1-year fell 1bp to 2.83% and the 5-year decreased 2bps to 3.57%. Chile Rates Tracker In Colombia, rates also traded lower in the session. In IBR swaps, the 1-year fell 3bps to 5.80% and the 10-year fell 6bps to 6.13%. Colombia Rates Tracker

Friday Events

  • In Brazil, external accounts data will be published. We expect a current account surplus of USD 400 million in February, above the USD 1.9 billion deficit in the same month last year. Also, we expect direct investment in the country (former FDI) to sum up to USD 4.5 billion in February. Then, February’s tax collection may be released. We forecast BRL 93 billion in tax collections, or a 1.1% increase in real terms.
  • In Mexico, the statistics institute (INEGI) will announce the growth rate of January’s retail sales. We forecast a growth of 7% y/y (December: 9%).
  • In Colombia, the central bank monetary policy meeting will take place. We believe the conditions are conducive for the central bank to speed up the easing process by cutting the policy rate by 50-bp to 6.75%. Moreover, the January activity coincident indicator (ISE) will be published.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa



< Back