Itaú BBA - The BRL weakens as the market reexamines BCB intervention

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The BRL weakens as the market reexamines BCB intervention

January 31, 2017

Governor Goldfajn stated BCB’s decision to roll-over the FX swaps expiring in March (USD 7 billion) will depend on market conditions

With information available until 6:30pm Brasilia time

Highlights

  • The BRL was the regional laggard (-0.70% to 3.1486/USD), as the market reassessed BCB’s intervention. The Real tested the 3.10/USD handle early in the session, but depreciated after Governor Goldfajn stated the Central Bank’s decision to roll-over the FX swaps expiring in March (roughly USD 7 billion) will depend on market conditions, adding that the options of a partial rollover and no rollover auction whatsoever are on the table. Andean pairs outperformed LatAm peers: CLP gained 0.18% to 647.30/USD, buoyed by copper, and the COP strengthened 0.31% to 2,923.38/USD, on the back of the rise in oil. The MXN weakened 0.33% to 20.85/USD by the time of writing.
  • Chilean rates narrowed across the curve, consistent with the loosening labor market (see Macro Backdrop). The Camara swaps curve bull-flattened (1s10s: -2bps). The front end implies between 72-82bps (depending on the term premium assumption) in rate cuts for this year, overall in line with our baseline. Colombian yields had a mixed behavior. Short IBR swaps fully price in 125bps of monetary easing for 2017. We foresee 200bps of rate cuts, taking the policy rate to 5.50%.

Macro Backdrop

BRAZIL

  • The consolidated public sector posted a primary budget deficit of BRL 156 billion (-2.5% of GDP) in 2016, slightly better than the fiscal target (-2.6% of GDP). The central government had a deficit of BRL 160 billion (-2.6% of GDP), regional governments had a surplus of BRL 5 billion (0.1% of GDP) and state-owned enterprises had a deficit of BRL 1 billion (0.0% of GDP). As a share of GDP, gross debt expanded to 69.5% (2015: 65.5%), while net debt rose to 45.9% (previous: 35.6%). In December, development bank BNDES returned 100 billion reais (1.6% of GDP) to the National Treasury, curbing the increase in gross debt for the year.  In our view, the approval and implementation of the spending cap and pension reform are pivotal to reverse the upward trend in public debt in a consistent way. The public spending cap, approved in late 2016, and the pension reform that Congress will debate in the coming months will be vital to gradually reverse the fiscal unbalance when economic growth resumes. With reforms, the upward trend in primary expenses — in place for at least the last 20 years — will be halted, producing positive implications of faster economic growth and lower interest rates, which will help to stabilize public debt in the medium term. Full Report
  • According to the national household survey (PNAD Contínua), Brazil’s nation-wide unemployment rate reached 12.0% in December, slightly above our estimate and market consensus (both at 11.9%). Using our seasonal adjustment, the rate increased for the 25th consecutive month, to 12.6% in December (previous: 12.3%). The indicator increased 3.0 p.p. from 9.0% one year earlier. Employment shrank 0.1% m/m and 2.1% y/y, while the labor force expanded 0.3% sequentially and 1.3% y/y. The participation rate (labor force over working-age population) increased to 61.5%, slightly above the previous month and its historical average (both at 61.3%). We expect unemployment to continue on an upward trend throughout the year, as the weakness in economic activity has not yet been fully reflected in the labor market.
  • The real wage bill increased for the second consecutive month at the margin, smoothing the downward trend seen in recent months. Nominal wages increased 0.4% m/m in December, but growth slowed down to 7.2% y/y (previous: 7.5%). The average real wage up ticked 0.2% m/m and grew 0.3% y/y, after 15 consecutive declines in that metric. The real wage bill is now 1.5% lower than one year before. Full Report
  • Business confidence in the industrial sector (FGV) increased 5.1% m/m in January, well above the preview (3.7%). Both current situation (4.6%) and expectations (5.4%) improved, while industrial demand increased 6.4% and remains on an upward trend. Sixteen out of twenty activities showed an increase (80% diffusion). The capacity utilization increased 1.7 p.p. (preview: 0.9 p.p.) and inventories decreased to 8.4% from 9.4%. Going forward, we expect the industrial confidence to increase.
  • The confidence in the service sector (FGV) increased 5.4% m/m in January, with increases both in current situation (6.8%) and expectations (3.8%). This data has low correlation with other service data, but continue to suggest a better scenario than the service sector revenue (PMS-IBGE).

MEXICO

  • GDP expanded at a firm pace in 4Q16. The flash estimate of GDP growth for 4Q16 came in at 2.2% y/y, in line with market expectations. Adjusting for calendar effects, GDP growth was also 2.2% y/y (3Q16: 2.0%). At the margin, GDP expanded 2.6% q/q saar in 4Q16 (3Q16: 4%). Service sectors grew 3.2% y/y in 4Q16 (3Q16: 3.3%), underpinned by solid consumption. In contrast, industrial production contracted 0.2% y/y (3Q16: -0.9%), dragged by falling oil output and less infrastructure spending by the public sector. Anyhow, stronger manufacturing has begun to partially offset the weakness of oil and construction, preventing a deeper deterioration of industrial activity. This preliminary figure implies annual GDP growth of 2.3% in 2016 (2015: 2.6%). While the flash result (as well as the time series) could be revised, it is likely that annual growth in 2016 was a bit above our forecast and market expectations (both at 2.1%). However, the prospects for 2017 have deteriorated, considering that higher inflation, tighter macro policies, and uncertainty surrounding trade relations with the U.S. will weigh on aggregate demand. We expect growth of 1.6% in 2017. Full Report

CHILE

  • The prolonged economic slowdown has led to a gradual rise in unemployment... The 4Q16 unemployment rate came in at 6.1%, up 0.3% from one year before, and in line with market expectations. Therefore, the unemployment rate averaged 6.5% in 2016 (2015: 6.3%) - the highest level since 2012. Despite the seemingly small rise in the unemployment, there are additional indications that the labor market is loosening further. In virtually every month of 2016, the participation rate was lower than in 2015, job creation is near historical lows and almost entirely composed of low quality roles and temporary in nature.
  • …and increased informal job growth. Low quality self-employment remains the driving force behind employment gains, increasing 4.6% y/y in 4Q16 (3Q16: 4.2%) and 6% in 2016 (2015: 0.8%). Meanwhile salaried employment contracted 0.1% y/y in the last quarter of 2016, in line with 3Q16, and expanded only 0.4% for the full year (2015: 2.3%). Within the latter, contracted workers declined 0.4% y/y 4Q16, whereas uncontracted workers increased 1.8%. Overall, uncontracted job growth rose sharply to 4.5% in 2016 (2015: 0.2%). As a significant economic recovery remains unlikely in the short-term, we expect the unemployment rate to continue to gradually edge up and the composition of employment growth to remain of low quality. Low growth and a weakening labor market will aid the ongoing disinflationary process, leading to additional monetary loosening this year. Full Report

Market Developments

  • GLOBAL MARKETS: U.S. Treasuries tightened after the Chicago PMI fell short of expectations. The 5-year dropped 6bps to 1.89% and the 30-year narrowed 3bps to 3.05%. Global Markets Tracker
  • CURRENCIES & COMMODITIES: The dollar weakening (DXY: -0.90%) lent a helping hand to the commodity complex. Brent gained 0.42% to USD 55.55/bbl, while soybean rose 0.17% and copper rallied 2.66%. In FX, Andean pairs outperformed LatAm peers: CLP gained 0.18% to 647.30/USD, buoyed by copper, and the COP strengthened 0.31% to 2,923.38/USD, on the back of the rise in oil. The MXN weakened 0.33% to 20.85/USD by the time of writing, and the BRL was the regional laggard (-0.70% to 3.1486/USD), as the market reassessed BCB’s intervention. The Real tested the 3.10/USD handle early in the session, but depreciated after Governor Goldfajn stated the Central Bank’s decision to roll-over the FX swaps expiring in March (roughly USD 7 billion) will depend on market conditions, adding that the options of a partial rollover and no rollover auction whatsoever are on the table. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm credit spreads were flattish. For the 5-year tenor, Brazil traded at 250bps, Colombia at 154bps and Chile stood at 83bps. Mexican CDS widened 2bps to 167bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The DI futures curve steepened as the Jan19x25 spread widened 8bps. The inflation-linked curve flattened, as the NTN-B 2022 widened 9bps to 5.89% and the 2050s inched down 2bps to 5.57%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican yields retraced for the third straight session. The TIIE swaps curve bull-flattened again, as the 1s10s spread tightened 4bps. The monetary policy pricing essentially converged to our scenario: there are 128bps in rate hikes implied in the curve (after filtering out the term premium) for this year. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: Chilean rates narrowed across the curve, consistent with the loosening labor market (see Macro Backdrop). The Camara swaps curve bull-flattened (1s10s: -2bps). The front end implies between 72-82bps (depending on the term premium assumption) in rate cuts for this year, overall in line with our baseline. Chile Rates Tracker Colombian yields had a mixed behavior. Short IBR swaps fully price in 125bps of monetary easing for 2017. We foresee 200bps of rate cuts, taking the policy rate to 5.50%. Colombia Rates Tracker

Upcoming Events 

  • In Brazil, December’s industrial production (Wed.) will be on focus. We expect production to expand 3.2% m/m, consistent with the widespread growth observed in the main coincident indicators. Moreover, Fenabrave vehicle sales for January will be released (Wed.) - we estimate sales of 153k vehicles. On the external sector, we expect the trade balance (Wed.) to post a surplus of USD 2.0 billion in January. Congress will return to its activities on Wednesday, one day before the elections for new Lower House and Senate leaders (Thu.). The Lava Jato Operation’s new rapporteur to replace Minister Teori Zavascki may be chosen this week.
  • In Mexico, the first survey that Banxico publishes after the liberalization of gasoline prices will be of note. Banxico will publish January’s expectations survey (Wed.). We expect a significant increase of short-term inflation expectations (especially for 2017), and a moderate increase for medium/long-term tenors. The statistics institute will also announce November’s gross fixed investment (Fri.). We expect it to print 0.3% y/y.
  • In Chile, the unemployment rate and BCCh's minutes are on the market's radar. BCCh will publish the minutes from the January monetary policy meeting (Fri.). With the market now pricing in more rate cuts than the 50-bp cycle outlined in the 4Q16 Inflation Report, the minutes could provide some indication on the magnitude of the easing cycle.
  • In Colombia, the Inflation Report and export data are on the radar. DANE will publish export data for December (Thu.). We expect to see exports of USD 3.1 billion on the back of higher oil prices. Also important, Banrep will publish the 4Q16 Inflation Report (Fri.).

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editor: Eduardo Marza



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