Itaú BBA - We now expect the BCB to deliver a 125-bp cut in May

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We now expect the BCB to deliver a 125-bp cut in May

May 15, 2017

We also forecast another 125-bp cut in July, with the Selic reaching 7.5% by October and staying there until end 2018 (we had a 8.25% terminal rate before).

With information available until 6:30pm Brasilia time

Highlights

  • We are changing our Copom call. The reason is a combination of weaker than anticipated short-term activity data, coming alongside a spell of very well behaved inflation numbers, a continuous drop in inflationary expectations, and the BCB's own communication tweaks. Hence, instead of a 100bps in the coming May 30-31 policy meeting, we now expect a sharper, 125bps cut, followed by another one in July, with the Selic reaching 7.5% by October and staying there until end 2018 (we had a 8.25% terminal rate before). The risk to our new call remains associated with the advance of the Social Security reform in the Congress. Full Report
  • The Brazilian curve bull steepened on BCB’s president closing remarks at the Annual Inflation Targeting Seminar last Friday (May 12). Governor Goldfajn did not lean against market pricing, and did not repeat that the 100bps pace of easing continues to be appropriate. The Jan-18 fell 14bps to 9.01% and the Jan-19 went down 11bps to 8.85%. For the May Copom meeting, the curve currently prices in roughly 124bps in rate cuts from almost 119bps as of Friday (May 12).
  • Oil prices rallied after Saudi Arabia and Russia signaled they are in favor of extending the deal for another nine months – longer than expected by the market. In LatAm FX, oil exporters outperformed (COP: +0.86% to 2,893.56/USD; MXN: +0.63% to 18.70/USD). The CLP gained 0.47% to 668.24/USD. At last, the BRL appreciated 0.42% closing at 3.1094/USD. In Brazil, the market will remain focused this week on the news flow regarding the pension reform. Lower House speaker Maia hinted that the reform’s first round vote in the plenary could be scheduled for the last week of May. 

Macro Backdrop

BRAZIL
  • 2018 inflation expectations are back trending down. According to BCB’s Focus survey, inflation expectations for 2017 declined to 3.93% (-8bps), and 2018 expectations dropped to 4.36% (-3bps). Year-end Selic expectations stood flat at 8.50% for 2017, 2018 and 2019. BRL expectations oscillated marginally as the market sees the currency at 3.25/USD by YE17 (previous: 3.23/USD) and at 3.36/USD by YE18 (previous: 3.40%). Also, 2017 GDP growth expectations ticked up to 0.50% from 0.47%. BCB Report
  • According to Central Bank, the IBC-Br Activity Index fell 0.44% mom s.a. in March. Despite the decline, the result came better than our forecast and market expectations (-0.6% and -0.9%, respectively). Relative to the same month in 2016, IBC-Br rose 1.0%. In addition, the past series (from Jan-16 to Feb-17) has been revised upward by 0.2 to 0.6 p.p.. Following the revision in the non-seasonally adjusted series, the new seasonally adjusted series rose 0.4% mom/sa in January and 1.4% in February, after remaining stable through 4Q16. The IBC-Br reinforces our view of strong GDP growth in 1Q17. The IBC-Br stands at 1.1% qoq/sa and the 3-month moving average at 0.3% yoy (our 1Q17 GDP scenario: 1.4% qoq/sa, -0.1% yoy). 
  • Macro Vision: is the correlation between industrial and confidence still valid? Confidence indicators have been on the rise since late 2015, while gross industrial production metrics have been stagnant amid considerable volatility. In this study, we show a model that explains this apparent decoupling, recognizing evidence that both the level and change in confidence are important in forecasting changes in industrial output. In sum, although the recent increase in confidence is relevant, the rebound will only gain traction once these indicators approach a neutral level. Full Report
  • After closing, the Central Bank called a roll over auction of up to 8,000 contracts on May 16. If this pace is maintained throughout the month, the BCB will have rolled over virtually (99%) the entire amount expiring in June (around USD 4.4 billion).
COLOMBIA
  • Central bank governor Juan José Echavarría’s presentation of the quarterly inflation report confirmed the balance of risks is tilted towards excessively weak activity. The inflation outlook remains broadly in line with the scenario laid out at previous monthly meetings, as inflation is expected to end this year near 4% - the upper bound of the 2%-4% tolerance range, led by lower food inflation. Further disinflation to around 3% is expected for 2018. However, compared to the previous report (released in February), the bank raised its short-term (the remainder of the year) inflation outlook, while lowering its medium-term (average 2018) outlook. The impact from the increased VAT tax rate in 1Q17, alongside the increasingly evident presence of indexation is likely behind the higher short-term forecasts. Inflation expectations – from both analyst surveys and market prices - have declined and are within the range for next year.
  • The increased concern over growth was the likely the reason behind the move to a more aggressive rate cut (50bps) at the April monetary policy meeting. The central bank noted that activity has underwhelmed since the previous report, with low confidence levels, weak sector data and a loosening labor market hinting at historically low consumption. Also, Banxico expects growth of 1.3% in 1Q17, a mild recovery in the 2H17, but not enough to offset low growth overall. The economy is expected to grow 1.8% this year (previously: 2%), down from 2% in 2016. In all, we expect the central bank to continue lowering the policy rate, but the pace of rate cuts remains unclear and likely to be data dependent. Echavarría noted that the board has new complicated elements to weigh this month, thus not diminishing the uncertainty over the pace of the next move. We see the policy rate ending the year at 5.5% (100 bps below the current level). Disappointing growth and declining headline inflation will be arguments for larger rate cuts, however, the unfavorable behavior of core and non-tradable inflation measures will likely generate some caution. Full Report Below
Market Developments 
  • GLOBAL MARKETS: Risk on day with equity markets strong on the green. In rates, DMs widened 1-2bps and EMs narrowed 2-3bps, on average. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities posted gains (CRB futures index: +0.58%) on the back of oil, copper (+0.63%) and soybeans (+0.23%). Oil prices jumped (Brent: +1.73% to USD 51.72/bbl) after the Saudi Arabian and Russian energy ministers said they are in favor of extending a production-cut deal for another nine months – longer than expected by the market. In FX, the dollar posted losses against the majors and commodity-linked currencies posted gains (+0.86%). Hence, all currencies under our coverage appreciated. The COP strengthened 0.86% to 2,893.56/USD. The MXN is trading 0.63% higher to 18.70/USD. The CLP gained 0.47% to 668.24/USD. At last, the BRL appreciated 0.42% closing at 3.1094/USD. Markets will remain focused this week on the news flow regarding the pension reform. Lower House speaker Maia hinted that the reform’s first round vote in the plenary could be scheduled for the last week of May. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: Credit spreads for the 5-year tenor narrowed all across LatAm. Chilean spreads ticked down to 72bps (-1bps). CDS in Mexico and Colombia both went down 2bps to 116bps and 128bps, respectively. Country risk in Brazil decreased further to 199bps (-4bps) - below the 200bps mark for the first time since January 2015. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: The Brazilian curve bull steepened on BCB’s president closing remarks at the Annual Inflation Targeting Seminar last Friday (May 12). Governor Goldfajn did not lean against market pricing, and did not repeat that the 100bps pace of easing continues to be appropriate. The Jan-18 fell 14bps to 9.01% and the Jan-19 went down 11bps to 8.85%. For the May Copom meeting, the curve currently prices in roughly 124bps in rate cuts from almost 119bps as of Friday (May 12). Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican rates narrowed 2-3bps in the session. In TIIE swaps, the 1-year decreased 2bps to 7.25% and the 10-year went down 3bps to 7.43%. Breakevens narrowed as well, the 5-year went down 6bps to 3.95%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields fell 1-2bps again. In Camara swaps, the 1-year went down 1bps to 2.56% and the 5-year fell 2bps to 3.52%. Chile Rates Tracker In Colombia, on the other hand, rates widened at the margin. In IBR Swaps, the 1-year went up 2bps to 5.33% and the 5-year increased 1bps to 5.46%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, labor market data is on the market's radar. CAGED formal job creation for April may come through. For April, we expect net destruction of 56k jobs seasonally adjusted. Our forecast may change following Industry Employment Data for the State of São Paulo (FIESP) (Wed.). Finally, industrial business confidence (CNI) for May will be released (Wed.) - we expect the current upward trend to continue.
  • In Mexico, the Central Bank’s board will meet to decide on the reference rate (Thu.). It will be hard for Banxico’s board to pause the hikes given the latest inflation data. Therefore, we expect Banxico to deliver a 25-bps rate hike (to 6.75%), in contrast with market expectations of no action.
  • In Chile, the central bank will publish the 1Q17 GDP (Thu.). The monthly GDP proxy recorded growth of 0.2% in the quarter, down from 0.5% in in 4Q16. The central bank will also publish the 1Q17 current account (Thu.). We expect a USD 700 million deficit, down from the USD 363 million surplus in 1Q16, mainly on the back of a smaller trade balance surplus in the quarter (USD 1.2 billion in 4Q16, after USD 2.2 billion in 1Q16). Finally, the central bank of Chile will hold its May monetary policy meeting (Thu.). We believe that sticky core service inflation and a favorable activity surprise gives leeway for a pause at this month’s meeting, so leaving the policy rate at 2.75%.
  • In Colombia, think-tank Fedesarrollo will release the April consumer confidence (Tue.). The depressed consumer sentiment hints at no quick recovery in private consumption related activity, thereby keeping the central bank’s concern over activity elevated. Moreover, the trade balance for the month of March will be published (Thu.). We expect a trade deficit of USD 780 million, smaller than the USD 1.1 billion deficit recorded one year ago. As a result, the trade deficit in 1Q17 would come in at USD 2.3 billion, narrowing from USD 3.6 billion in 1Q16. Going forward, the national statistics authority will publish the supply-side breakdown of GDP growth for 1Q17 (Fri.). Based on activity indicators for the quarter, we estimate activity fell 0.1% from the previous quarter, resulting in annual growth of 1.4%, down from the 1.6% in 4Q16. Finally, the March activity coincident indicator (ISE) will be published (Fri.). Recent indicators reaffirmed that the economy was weak in the first quarter of the year. In the previous month, ISE grew a mild 0.3% year over year. 

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

Today's editors: Eduardo Marza, Pedro Correa


Macro Report

COLOMBIA: Inflation Report – Growth concerns at the forefront


Central bank governor Juan José Echavarría’s presentation of the quarterly inflation report confirmed the balance of risks is tilted towards excessively weak activity. The inflation outlook remains broadly in line with the scenario laid out at previous monthly meetings, as inflation is expected to end this year near 4% - the upper bound of the 2%-4% target range, led by lower food inflation. Further disinflation to around 3% is expected for 2018. However, compared to the previous report (released in February), the bank raised its short-term (the remainder of the year) inflation outlook, while lowering its medium-term (average 2018) outlook. The impact from the increased VAT tax rate in 1Q17, alongside the increasingly evident presence of indexation is likely behind the higher short-term forecasts. Inflation expectations – from both analyst surveys and market prices - have declined and are within the target range for next year.

The increased concern over growth was the likely the reason behind the move to a more aggressive rate cut (50bps) at the April monetary policy meeting. The central bank noted that activity has underwhelmed since the previous report, with low confidence levels, weak sector data and a loosening labor market hinting at historically low consumption. The bank authorities believe investment may show a mild recovery, led by civil works programs. In all, the central bank expects growth of 1.3% in 1Q17, a mild recovery in the 2H17, but not enough to offset low growth overall. The economy is expected to grow 1.8% this year (2% in the previous report), down from 2% in 2016.  

Overall, the central bank notes the Colombian economy continues its adjustment process to the 2014 shocks. The current account deficit will likely continue to correct. Inflation is on the decline, even though there are some uncomfortable signs from core measures. Meanwhile, and seemingly at the forefront of the central bank’s mind, there is a higher risk that the economic slowdown becomes excessive beyond the adjustment to the national income deterioration. 

We expect the central bank to continue lowering the policy rate, but the pace of rate cuts remains unclear and likely to be data dependent. Echavarría noted that the board has new complicated elements to weigh this month, thus not diminishing the uncertainty over the pace of the next move. We see the policy rate ending the year at 5.5% (100 bps below the current level). Disappointing growth and declining headline inflation will be arguments for larger rate cuts, however, the unfavorable behavior of core and non-tradable inflation measures will likely generate some caution. 

Vittorio Peretti



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