Itaú BBA - The MXN trades below 18/USD for the first time since May 2016

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The MXN trades below 18/USD for the first time since May 2016

June 14, 2017

LatAm FX strengthened after soft CPI data in the US, but later staged a correction as the FOMC has not changed its guidance meaningfully.

With information available until 6:30pm Brasilia time

Highlights

  • LatAm FX strengthened after soft CPI data in the US, but later staged a correction as the FOMC has not changed its guidance meaningfully. In the Q&A, Chairwoman Yellen stresses its “important not to overreact to a few inflation readings”. Moreover, the Fed provided a detailed schedule of the balance sheet normalization and Yellen suggested that it could begin “relatively soon”. We now see the start of the balance sheet normalization in September (instead of December), and the next Fed hike in December (instead of September).
  • In FX, the BRL outperformed, closing at 3.2752/USD (+1.20%). Then, the MXN appreciated for the eighth consecutive session, trading at 17.92/USD (+0.74%) – level last seen in May 2016. Andean markets closed before the Fed decision. On the back of lower oil prices, the COP stood broadly flat at 2,934.80/USD (-0.06%). On the other hand, the CLP strengthened 0.21% to 659.91/USD. 
  • In our Monthly Strategy report, we argue that the complex political situation in Brazil will probably delay needed reforms that require congressional approval. This increases the challenge to regain fiscal equilibrium, with negative impacts on the BRL and local rates. 

Macro Backdrop

BRAZIL
  • According to the IBGE monthly services survey (PMS), services sector real revenue advanced 1% mom s.a. in April, following a strong decrease in last month observation. The year-over-year growth came at -5.6%, above the median of expectations (consensus: -5.8%) but in line with the figure used in our GDP tracking (-5.6%). The positive headline is consistent with industrial production, retail sales and other monthly indicators showing a widespread grow in April. The breakdown by component shows stability in two sectors, decline in other two and growth in the transportation component. 
  • According to FIESP, São Paulo state industry employment fell 0.3% mom s.a. in May, with a destruction of 3000 jobs. Along with other economic activity data, we forecast a creation of 49k formal jobs (CAGED) in May. Nonetheless, the results means a destruction of 9k jobs in seasonally adjusted terms (3mmavg will reach -37k, from -50k). 
  • Our monthly GDP proxy was virtually unchanged during in April (0.1% mom s.a.). However, compared to one year earlier, monthly GDP fell 1.4% and went back to negative territory after posting in March the first positive reading in 23 months. In the quarter ended in April, the indicator went up 0.4% compared to the first quarter of year. These figures suggest that growth will be slower in 2Q17 than in 1Q17. Notwithstanding the stability in seasonally-adjusted terms, six out of ten PIBIU components posted declines. The sharpest drop was in construction (-1.8%) and the biggest gain in retail (1.2%). Preliminary figures for May point to falling retail sales, suggesting a slight retreat in PIBIU during the month. Full Report
  • Gasoline (-5.8%) and diesel (-2.3%) prices at refineries were reduced. We estimate the impact over June IPCA to be around -1bp and over July’s roughly -3bps. 
  • The BCB placed the full offering of 8,200 FX swaps. After closing, the central bank called for a roll over auction of up to 8,200 contracts on June 16. 

COLOMBIA

  • The central bank’s June monthly expectation survey shows a mild retreat of inflation expectations. Such a development would allow the central bank to continue with the gradual 25-bp rate cut pace at its monetary policy meeting later this month (June 30) as, in the previous meeting, most in the board remained uneasy over the future evolution of inflation. The minutes of the split decision to cut the policy rate from 6.50% to 6.25% last month indicate that sticky core inflation and the previous uptick of inflation expectations triggered the reversal from a 50-bp cut in April. Since that meeting, headline inflation moderated in May, but the dynamics remain uncomfortable. The June survey shows that the 2017 inflation expectation edged down to 4.32% from 4.38% in the May survey. Meanwhile, the 2018 inflation expectation was stable at 3.5%. The 2-year horizon inflation expectation decreased to 3.21% from 3.31% last month. The core inflation expectation measure (excluding food prices) moderated to 3.4% in 12 months (3.5% previously) and was stable at 3.08% in two years. 
  • The surveyed respondents expect a 25-bp rate cut this month, followed by consecutive cuts of the same magnitude until the policy rate reaches 5.5% in August, thereafter pausing until January 2018, before taking the rate to 5.0% by May next year. We too expect the policy rate to end the year at 5.50%, with a 25bp cut this month, and further easing to 4.5% next year. The pace of rate cuts (potentially including pauses) remains data-dependent. 

Market Developments 

  • GLOBAL MARKETS: US rates narrowed (5-year: -4bps to 1.74%) after inflation and retail data. CPI inflation declined 0.1% m/m, with weakness across the board. Core CPI was 0.06% m/m and 1.7% y/y, well below expectations. Later in the session, markets staged some correction as the FOMC has not changed its guidance meaningfully. Even after a third consecutive below expected core CPI print, the softer underlying inflation is seen by the board as transitory. Near-term economic risks are deemed as roughly balanced, but the committee “is monitoring inflation developments closely”. Furthermore, the Fed’s median dot plot didn’t change significantly. Then, PCE projections for 2017 changed to 1.6% (from: 1.9%) and unemployment forecasts were revised downwards (2017: to 4.3% from 4.5%; 2018 and 2019: to 4.2% from 4.5%; long-run: to 4.6% from 4.7%). After the FOMC communication and the softer May CPI print, we now see the start of the balance sheet normalization in September (instead of December), and the next Fed hike in December (instead of September). Global Markets Tracker
  • CURRENCIES & COMMODITIES: Oil prices dropped (WTI: -3.87% to 44.66/USD – 5-week low) after, according to the EIA report, an unexpectedly large weekly build in US gasoline inventories. In addition, EIA said it expected growth in non-Opec supply to outpace demand growth next year. In FX, currencies under our coverage posted gains after the FOMC. However, on the back of lower oil prices, the COP stood broadly flat at 2,934.80/USD (-0.06%). On the other hand, the CLP strengthened 0.21% to 659.91/USD. The BRL outperformed, closing at 3.2752/USD (+1.20%). Finally, the MXN appreciated for eight consecutive sessions, trading at 17.92/USD (+0.74%) – level last seen in May 2016. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads for the 5-year tenor narrowed all across LatAm. Chilean spreads inched down 1bp to 66bps and Mexican went to 106bps (-2bps). In Colombia, country risk narrowed 3bps to 120bps. At last, CDS in Brazil fell 6bps to 230bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bull flattened after the Fed. In DI futures, the Jan-18 fell 3bps to 9.17% and the Jan-21 went down 10bps to 10.26%. Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican yields also narrowed tracking US Treasuries. In TIIE swaps, the 1-year fell 6bps to 7.37% and the 5-year fell 7bps to 7.03%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, long rates narrowed 1-4bps in the session. In Camara swaps, the 18-month inched down 1bp to 2.59%, whereas past the 8-year, they went down 4bps. Chile Rates Tracker In Colombia, yields fell at the margin again. In IBR swaps, while the 1-year stood flat at 5.10%, the 5-year inched down 1bp to 5.15%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, the BCB may release its monthly activity index (IBC-Br) for April during the week. 
  • In Chile, the central bank will hold its June monetary policy meeting (Thu.). The central bank has implemented four 25-bp rate cuts in the first five months of the year, taking the policy rate to 2.5%. We expect BCCh to stay on hold this month. The minutes from the previous meeting alongside the 2Q inflation report released after the May meeting reveal a board that appears content to wait and observe how the economy unfolds given the monetary stimulus already implemented. 
  • In Colombia, activity indicators for the month of April will be published (Thu.). We expect industrial production to decrease 5.0% year over year (+4.8% in March). Meanwhile, retail sales likely saw a 0% growth rate (+1.9% previously). Then, think-tank Fedesarrollo will release the May consumer confidence (Thu.). Falling inflation, lower interest rates, and a firmer currency will likely aid some confidence recovery ahead. During the week, the central bank is expected to publish the current account balance for 1Q17. We expect a USD 2.4 billion deficit, smaller than the USD 3.6 billion deficit in 1Q16, as the trade balance of goods improved from one year ago on the back of recovering commodity prices and a weakening domestic demand.

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa




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