Itaú BBA - The BRL weakens and yields widen

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The BRL weakens and yields widen

February 24, 2017

Some profit taking in Brazil before the long holiday (Carnival) and political concerns.

With information available until 6:30pm Brasilia time


  • In rates, some profit taking in Brazil before the long holiday (Carnival) and political concerns. While short term DI Futures traded range bound (Jan-18: +1bp to 10.35%), longer term rates increased substanyially (Jan-20: +7bps to 9.98%). 
  • In LatAm FX, all currencies under our coverage depreciated. The MXN traded 1.11% lower to 19.87/USD. The CLP decreased 0.72% to 646.19/USD. The COP went to 2,890.09/USD (-0.73%). Finally, the BRL was the regional laggard, depreciating 1.52% to 3.1104/USD.

Macro Backdrop

  • The consolidated public sector posted a primary budget surplus of BRL 36.7 billion in January, topping our forecast (BRL 27.0 billion) and market consensus (BRL 18.8 billion). The central government (BRL 26.3 bn) as well as regional governments (BRL 10.8 bn) delivered larger-than-expected surpluses, while state-owned companies had a deficit of BRL 384 million. The nominal deficit accumulated over 12 months declined to 8.5% from 9.0% of GDP, but excluding the Central Bank’s gains/losses on FX swap transactions, the nominal deficit stands at a high level (10% of GDP), reinforcing the need for reforms (particularly the pension reform) to reverse the structural trend of fiscal deterioration. Under the National Treasury’s methodology, the central government posted a surplus of BRL 19.0 billion in January, beating our estimate (BRL 2.0 billion) and market expectations (BRL 9.4 billion). Over 12 months, the central government’s primary deficit narrowed to 2.4% of GDP in January from 2.5% of GDP in December. 
  • Public debt dynamics was relatively stable during the month, but remains unfavorable. The general government’s gross debt edged up to 69.7% of GDP in January from 69.6%, while net debt advanced to 46.4% of GDP from 46.0% in December. If approved, the pension reform will be essential for public debt dynamics, by reversing the current upward trend in pension expenses and possibly setting the necessary conditions for the structural decline in interest rates and rebound in economic activity. Full Report
  • Unemployment rate still rising, reaching 13.0% in January. According to the national household survey (PNAD – Continua), the national unemployment rate reached 12.6% in January, broadly in line with our estimate and the market’s (both at 12.5%). Seasonally adjusted, the unemployment rate climbed to 13.0% in the quarter ended in January (4Q16: 12.7%). The rise in unemployment was due to a 0.3% rise in the workforce, while employment stood flat, revealing relative stability on the margin. Nominal wages continued to decelerate, increasing 6.5% y/y from 7.2% in December. Sequentially, this was a 0.2% rise seasonally adjusted. The persistent rise in unemployment is consistent with our view that the labor market will continue to react negatively to the present economic weakness. We expect unemployment to continue its upward trend, as the weakness in economic activity has not yet been fully reflected in the labor market. 
  • Market Conditions remain expansionary in February. The Itaú Unibanco Market Conditions Index1 (IU-MCI) was virtually flat in February. The three-month moving average rose to 0.63 from 0.57. The Brazilian financial variables subcomponent increased from 1.21 at the end of January to 1.47 in February. On the other hand, the commodity prices subcomponent fell slightly in February, from 0.37 in January to 0.22, indicating a softer pace of price increases. The moving average was stable at around 0.44. 
  • Business confidence in the industrial sector decreased 1.3% m/m in February. According to FGV, business confidence in the industrial sector was slightly above its preview (-2.0%), with decreases both in current situation (-0.7%) and expectations (-1.9%). Fourteen out of twenty activities showed an increase (diffusion: 70%), consistent with a better aggregate result for confidence. Going forward, we expect the industrial confidence to increase. 
  • The confidence in the service sector (FGV) increased 0.6% m/m in February. Expectations increased 2.2% m/m and current situation fell 1.1%. This data has low correlation with other service data, but continue to suggest a better scenario than the service sector revenue (PMS-IBGE) and milder contractions in employment. 
  • Trade deficit narrowed 1.3% of GDP in 4Q16 (3Q16: 1.5%)… There was a large improvement in the non-energy deficit (now virtually zero, from 0.4% of GDP in 3Q16) partly offset by a deterioration of the energy deficit (1.3% of GDP, 3Q16: 1.1% of GDP). Transfers picked up in 4Q16 to 2.6% of GDP (3Q16: 2.4% of GDP).
  • …Meanwhile, foreign direct investment is now enough to finance almost the entire current account deficit… Net direct investment stood at USD 4.9 billion in 4Q16 and the four-quarter rolling measure came in at USD 27.5 billion. Moreover, there were inflows into domestic government bonds in 4Q16 (USD 4.1 billion) which marks two consecutive quarters of inflows (after three consecutive quarters of outflows). Nevertheless, over four quarters, foreign investment in domestic government bonds is still slightly negative (USD 1.5 billion). 
  • …In all, the current account deficit narrowed significantly in 4Q16, on the back of an improving trade balance and a pick-up of remittances. Mexico’s current-account deficit came in at USD 3.4 billion in 4Q16 – closer to our forecast (USD 4.4 billion) than to the consensus (USD 5.3 billion) – which brought the four-quarter rolling deficit to USD 27.9 billion (2.7% of GDP) (3Q16: USD 32 billion). At the margin, the narrowing was more significant, with the seasonally adjusted deficit decreasing to 1.8% of GDP in 4Q16 (3Q16: 3.3% of GDP). Looking ahead, we expect the current-account deficit to narrow - from 2.7% of GDP in 2016 to 2.3% in 2017- as the economy experiences a rebalancing in its sources of growth (with weaker domestic demand partly offset by firmer exports). Full Report
  • Mexico’s retail sales grew at a robust pace in December relatively to one year before. Retail sales expanded 9.0% y/y, higher than our forecast (6.8%), but below market expectations (9.4%). The growth rate of 4Q16 stood at 9.8% y/y (3Q16: 8.3%). Although seasonally-adjusted sales fell from November (by 1.4%), the momentum of retail sales remains strong. The quarter-over-quarter annualized growth edged up to 7.3% (from 7.1% q/q sa in 3Q16) due to strong performances in October and November. Looking ahead, we expect a slowdown of retail sales that will become more visible in 1Q17. Inflation jumped to 4.7% in January, eroding real wage growth. Likewise, consumer confidence fell to a historic low in the same month. Moreover, tighter macroeconomic policies will likely hurt the labor market as well as curb the strong growth of consumer credit. Full Report
  • The central bank of Colombia surprised the market for the third consecutive month by cutting the policy rate by 25-bp to 7.25%. We, alongside 71% of the analysts surveyed by Bloomberg, were expecting the central bank to stay on hold following the decision to keep rates on-hold the previous month. In the press conference, both Finance Minister and Central Bank General Manager mentioned the sharp fall of consumer confidence to a historical low as the key factor behind the rate cut. Also, the board warns in the press statement that if this is reflected to private consumption, growth in 2017 could be around 2%, representing no recovery from last year. While the February rate cut came as a surprise, it reinforces our view that the policy rate will end this year at 5.5%. The timing of rate cuts has become more unpredictable. Still, the negative output gap, the fading impact of supply-side shocks on inflation and the currently high real interest rate support further easing ahead. Full Report

Market Developments 

  • GLOBAL MARKETS: Risk appetite increased as volatility measures went up on a profit-taking global movement. Long US Treasuries, though, decreased substantially (10-year: -5bps to 2.33%), after data showed new home sales grew less than expected in January and consumer sentiment eased last month. The Fed funds futures implied probability of a March hike increased to 40% from 38% as of Thursday. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities were mixed (CRB Futures Index: -0.37%) and oil prices decreased (Brent: -0.94% to USD 56.05/bbl). Iron Ore is up for the first time in the last 4 sessions (+0.45%). In LatAm FX, all currencies under our coverage depreciated. The MXN traded 1.11% lower to 19.87/USD. The CLP decreased 0.72% to 646.19/USD. The COP went  to 2,890.09/USD (-0.73%). Finally, the BRL was the regional laggard, depreciating 1.52% to 3.1104/USD. FX & Commodities Tracker 
  • CDS SPREADS & EXTERNAL BONDS: LatAm credit spreads for the 5-year tenor increased at the margin. Colombian spreads increased 1bp to 137bps. In Chile and Mexico, spreads stood flat at 74bps and 140bps, respectively. Meanwhile, CDS in Brazil increased the most (+2bps) to 222bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Some profit taking before the long holiday (Carnival) and political concerns. While short term DI Futures traded range bound (Jan-18: +1bp to 10.35%), longer term rates inched up substantially (Jan-20: +7bps to 9.98%). The curve now implies 286bps to 329bps (Thursday: 441bps to 482bps) in rate cuts for 2017. Brazil Rates Tracker
  • LOCAL RATES - Mexico: The Mexican curve shifted up 4bps, on average. In TIIE swaps, rates widened as the 10-year inched up 4bps to 7.78%. Real rates, though, fell (Jun-22: -2bps to 2.88%). Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: The Camara curve bull flattened (10s1s: -6bps). The 5-year fell 4bps to 3.61%. Chile Rates Tracker  The IBR curve traded range bound. The 1-year fell 1bp to 6.43% and the 5-year increased 3bps to 5.82%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, the Copom minutes from the February meeting will take center stage (Thu.). The minutes will likely bring about the reasoning behind the Copom’s decision. Then, on economic activity, CAGED formal job creation for January may come through. We expect net closings of 36k jobs, which is -4k in seasonally adjusted terms. Also, February’s vehicle sales (Fenabrave) will come through (Wed.). We expect sales of 120k vehicles. Finally, on external side, the trade balance may be released. We expect a surplus of USD 3.4 billion in February, above the USD 3 billion surplus in February last year. 
  • In Mexico, the statistics institute (INEGI) will announce January’s unemployment rate (Mon.). We expect the unemployment rate to post 3.8% (below the 4.2% rate recorded in January 2016). Also, INEGI will publish January’s trade balance (Mon.). We expect the trade deficit to continue narrowing at the margin. Moreover, the Central Bank will publish the first Quarterly Inflation Report of the year (Wed.). We expect Banxico to lower its official GDP growth forecasts - to catch up with the deterioration of the economic outlook - and the inflation forecast for 2017 will be revised up. Then, the Central Bank will publish February’s Economist Survey (Thu.). We do not expect significant changes in inflation expectations. Then, the Ministry of Finance (“Hacienda”) will announce January’s fiscal balance (Thu.). We expect the fiscal deficit indicators to continue narrowing. Finally, INEGI will publish December’s gross fixed investment (Fri.). We forecast that gross fixed investment grew 1% y/y. 
  • In Chile, the national statistics agency (INE) will publish the industrial activity indicators for the month of January (Tue.). INE will rebase the data to 2013, in line with the upcoming change in national accounts. Then, INE will also publish the national unemployment rate for the quarter ending in January (Tue.). We anticipate some further evidence of labor market loosening with an increase in the unemployment rate to 6.1% from 5.8% in the equivalent period last year. Moreover, the central bank will publish the minutes from the February monetary policy meeting (Wed.). We expect the decision was not unanimous, with some in the board voting for a rate cut. Also, INE will publish the rebased private consumption activity indicators (Fri.). Retail sales have performed favorably, aided by an influx of consumption tourism and falling prices. 
  • In Colombia, the institute of statistics (DANE) will publish the January national unemployment rate (Tue.). We expect the labor market to loosen ahead as the Colombian economy remains weak. Also, DANE will publish export data for January (Thu.). We expect to see exports of USD 2.7 billion (USD 1.9 billion one year before), a 47% annual increase.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa

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