Itaú BBA - We now expect the Copom to deliver a 100-bp cut next week

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We now expect the Copom to deliver a 100-bp cut next week

July 21, 2017

Copom Cockpit: the disinflationary scenario prevails.

With information available until 6:30pm Brasilia time


  • Although in theory the recent political uncertainty shock could have ambiguous effects on inflation, most recent data suggest that the impact has been largely disinflationary so far. Thus, we expect the Copom to maintain the easing pace of the previous meeting next Wednesday (see Macro Backdrop).
  • Brazilian nominals widened on some profit taking, whereas short linkers narrowed substantially (Aug-18: -29bps to 3.82%) echoing the inflationary effect of the fuel tax hikes announced by the government. Mexican yields widened 1-2bps in the session as the unemployment rate came in lower than expected (see Macro Backdrop).
  • The risk-off tone abroad and the commodity rout took a toll on LatAm FX. By the time of writing, the MXN was trading at 17.6542/USD (-0.95%). The COP depreciated 0.46% to 3,014/USD and the CLP was stable at 651.27/USD (+0.08%). The BRL trimmed the weekly gains, closing at to 3.1433/USD (-0.70%).

Macro Backdrop

  • Copom Cockpit: the disinflationary scenario prevails. The Copom will meet again next week (July 25-26). Recent data pictures an environment of low inflation and anchored expectations, with mixed signals in activity data, suggesting a gradual albeit increasingly widespread recovery. Copom's inflation forecasts are expected to drop slightly for 2017 and 2018. In its statement, we expect the Copom to indicate that the extent of the monetary cycle and the easing pace will depend on inflation forecasts and expectations, the evolution of economic activity data and risk factors associated with the scenario - including non-economic factors. We revised our forecast for the Selic rate at the end of the cycle to 7.0%, a level that would be reached in 1Q18. Our scenario contemplates reductions of 75bps in September 2017, 50bps in October and December, taking the Selic rate to 7.5% by the end of 2017, and more parsimonious movements at the beginning of next year, with two 25-bp reductions finally taking the Selic rate to 7.0%. Full Report
  • The government published its Bimonthly Report which confirms our scenario that compliance with the 2017 target (BRL 139 billion deficit or -2.2% of GDP) is challenging and hinges on extraordinary revenues. As announced Thursday, the revised government estimates led to an increase of BRL 6 billion of the budget freeze and to hikes in fuel taxes that should mean BRL 10 billion in extra revenues this year. This follows the net effect of a decrease of BRL 26 billion in revenues (mostly owing to disappointing recurrent tax collection); of a BRL 4 billion decrease in transfers to states and municipalities and a BRL 9 billon increase in mandatory spending. Hence, the 2017 budget freeze currently totals BRL 45 billion (from BRL 39 billion in the May Bimonthly Report). Delivering such sizeable budget cut is likely unfeasible, but it could be reduced  ahead with downside surprises in mandatory spending and with BRL 4 billion extraordinary revenues that still might materialize this year. Full discussion below.
  • The current account surplus totaled USD 1.3 billion in June, in line with our estimate (USD 1.3 billion) and market consensus (USD 1.4 billion). The reading was better than the USD 2.5 billion deficit recorded in June 2016. The current account deficit accumulated over 12 months receded to USD 14.4 billion or 0.8% of GDP. Year-to-date, the current account posted a USD 715 million surplus, the highest since 2007. The seasonally-adjusted annualized three-month moving average, however, moderated at the margin, as the surplus shrank to USD 2.6 billion in June from USD 7 billion in May. The biggest positive contribution again came from the trade balance, with a USD 7.0 billion surplus, up from USD 3.7 billion in June 2016. 
  • The strong trade surplus has helped to maintain low current account deficits. We still expect large trade surpluses this year, but a rebound in domestic demand and lower commodity prices tend to produce slightly weaker readings in the next months. Preliminary figures for July already point to some moderation in the trade surplus. Thus, the current account deficit is set to widen from current levels as the year advances. 
  • In the financial account, direct investment in the country (DIC) added up to USD 4.0 billion, topping our estimate (USD 2.3 billion) and market consensus (USD 2.5 billion). Equity capital transactions accounted for 77% of total DIC. DIC accumulated over 12 months remained around USD 81 billion. Preliminary data published by the Central Bank show DIC inflows remain strong in July (USD 3.1 billion as of July 19). Foreign investment in the local capital markets was negative again, by USD 2.6 billion, driven by USD 1.8 billion outflows from fixed income and USD 861 million outflows from the stock market. In all, DIC remains resilient, reducing Brazil’s reliance on volatile capital flows. However, portfolio flows (stocks and fixed income) are still negative over 12 months. Full Report
  • On Thursday, the Finance Ministry announced the increase of the PIS/Cofins taxes on fuel (gasoline, diesel and ethanol). We estimate the impact over this year’s IPCA to be +0.57 p.p. (+0.05 p.p. in July and +0.52 p.p. in August). This way, our preliminary IPCA forecast for July went up to 0.12% (from 0.07%) and for August rose to 0.57% (from 0.05%). For September, our estimate stood at 0.38%.
  • The BCB placed the full offering of 8,300 FX swaps. After closing, the central bank announced another roll over auction of up to 8,300 contracts (USD 415 million) on July 24.
  • The unemployment rate came in surprisingly low in June. The unemployment rate posted 3.3%, below our forecast and median market expectations (both 3.5%) and 0.9 p.p. lower than the unemployment rate reported in the same month of last year (3.9%). Importantly, this decrease in the unemployment rate is not attributable to a decrease in the participation rate (actually the participation rate was 0.1 p.p. higher in June 2017 than in June 2016). Formal employment growth was robust in June (4.3% year-over-year) and grew consistently above 4% throughout the first six months of 2017. At the margin, the seasonally-adjusted unemployment rate decreased to 3.3% in June (from 3.5% in May).
  • Overall, the main takeaway is that there is no visible deterioration in the labor market as of 1H17. Looking ahead, however, we do expect less tight labor market conditions in coming months, considering that the substantial deterioration of gross fixed investment will likely affect employment growth. Also, we note that the current low level of the unemployment rate could be associated with lower potential GDP growth (economy absorbs slack faster) and/or the effects of the labor reform approved in 2012 and implemented gradually since then (lowering labor costs for firms, creating new hiring mechanisms, and cutting back red tape).


  • The coincident activity indicator (ISE) for the month of May remained weak but there are signs of stabilization. The seasonally adjusted series grew a mild 1.2% year over year (1.5% in April), falling in between our 1.0% forecast and the market consensus of 1.4%. As a result, growth in the first five months of the year came in at 0.7%, notably inferior to the 2.5% in the 2016 equivalent period, while the rolling 12-month growth rate has been 1.2% since March. Sequentially, activity posted its first monthly gain (+0.5% mom) since November last year. Nevertheless, activity declined 2.1% qoq/saar in the quarter ending in May, down from -1.7% in 1Q17 (+3.0% qoq/saar in 4Q16). 
  • We expect GDP growth of 1.6% this year, a slowdown from the 2.0% recorded last year, with risks tilted to the downside. The weak activity performance will likely lead Banrep to implement another rate cut next week (25bps to 5.5%).
Market Developments 
  • GLOBAL MARKETS: Markets traded with a risk off tone, with equity markets on the red and volatility gauges at low levels. Safe haven assets outperformed as gold rose 0.84% and the JPY appreciated 0.70%. Global Markets Tracker
  • CURRENCIES & COMMODITIES: Commodities were weak in the session. Ahead of the meeting between major oil producers, oil prices went down (WTI: -2.34% to USD 45.82/bbl). In agriculture, wheat prices fell 1.29% and corn fell 2.88%. Likewise, metals were dragged down by iron ore (-0.51%). In FX, LatAm pairs underperformed, dragged down by commodities (Commodity FX: -0.45%). The MXN is trading at 17.6542/USD (-0.95%). The COP depreciated 0.46% to 3,014/USD and the CLP was stable at 651.27/USD (+0.08%). The BRL posted losses of 0.70% to 3.1433/USD. FX & Commodities Tracker
  • CDS SPREADS & EXTERNAL BONDS: LatAm credit spreads traded range bound in the session. For the 5-year tenor, Colombian, Chilean and Brazilian spreads stood flat at 131bps, 65bps and 211bps, respectively. In Mexico, CDS inched up 1bp to 105bps. External Bonds and CDS Tracker
  • LOCAL RATES – Brazil: Brazilian nominal rates widened on profit taking. In DI futures, the belly was under pressure as the Jan-19 went up 6bps to 8.40%. On the other hand, real rates narrowed substantially as the government announced tax hikes (Aug-18: -29bps to 3.82%). Brazil Rates Tracker
  • LOCAL RATES - Mexico: Mexican yields widened 1-2bps in the session as the unemployment rate came in lower than expected. In TIIE swaps, the 1-year increased 2bps to 7.33% and the 5-year also went up 2bps to 6.85%. Mexico Rates Tracker
  • LOCAL RATES – Chile and Colombia: In Chile, yields narrowed 1-3bps. In Camara swaps, the 1-year went down 2bps to 2.42% and the 5-year inched down 1bp to 3.43%. Chile Rates Tracker In Colombia, markets reopened after Thursday’s holiday. In IBR swaps, most yields widened at the margin. The 1-year inched up 1bp to 5.06% and the 5-year increased 2bps to 5.48%. Colombia Rates Tracker

Upcoming Events

  • In Brazil, markets will focus on the Copom meeting (Wed.). We expect the Copom to deliver a 100-bp cut. Moreover, the nationwide unemployment rate for June will come out (Fri.) - we expect a 10bps increase to 13.2% (according to our seasonal adjustment). In addition, FGV’s monthly surveys for July on consumer, retail, construction and industry will be released through the week. Additionally, the economic uncertainty indicator for July, also from FGV, will be released (Fri.). These surveys will provide an initial glimpse on economic activity in the third quarter. On fiscal accounts, the consolidated primary budget balance for June will come through (Fri.). We expect a BRL 21.9 billion deficit. 
  • In Mexico, INEGI will publish CPI inflation figures for the first half of July (Mon.). We expect bi-weekly inflation to come in at 0.20%. Assuming our forecast is correct, annual CPI inflation would decrease to 6.24% year-over-year (from 6.33% in the second half of June). At the same time, INEGI will also publish May’s monthly GDP proxy (IGAE) (Mon.), which we forecast to expand at the pace of 2.8% year-over-year (after falling 0.7% in April, dragged by negative calendar effects). Then, INEGI will announce the growth rate of May’s retail sales (Tue.). We forecast at 2.3% year-over-year (up from 1.4% in April). Moreover, INEGI will announce June’s trade balance (Thu.). We expect the trade deficit to widen in June, due to an upsurge of gasoline imports which likely affected the energy balance. Finally, the Ministry of Finance (Hacienda) will announce June’s fiscal balance (Fri.). We expect the fiscal deficit indicators to continue narrowing, as fiscal consolidation makes headway. Oil revenues, however, will likely weaken, given the drop of international oil prices observed in June. 
  • In Chile, the central bank of Chile will publish the minutes of the July monetary policy meeting (Fri.). We expect the minutes to reveal additional details on the central bank’s evaluation of inflation dynamics. Additionally, we will be looking at whether other options (beyond staying on hold) were discussed and if the decision had the full backing of the board. Also, the national statistics agency (INE) will publish industrial activity indicators for the month of June (Fri.). We expect manufacturing production to expand 0.7% from last year (+1.9% in May), resulting in growth of -1.6% in 2Q17 (-0.4% in 1Q17). 
  • In Colombia, local think-tank Fedesarrollo will publish the June industrial and retail confidence indicators (Wed.). Activity has disappointed and we expect confidence levels to remain low in the months ahead, indicating an activity recovery is not imminent. Moreover, Banrep hosts its monthly monetary policy meeting (Thu.). Since the previous meeting, activity indicators for May disappointed the market further and headline inflation continued to fall. However, core inflation remains at a high level and medium-term inflation expectations ticked up. Additionally, numerous board members (including two who likely voted to lower rates by 50-bps) have communicated that they do not see room for much further easing. In this context, we expect only two additional 25-bp rate cuts before the end of this year (one next week and the other next month). 
  • In Argentina, the central bank will hold its biweekly monetary policy meeting (Tue.). We expect the central bank to stay on-hold for a little longer. Also, the INDEC will publish the EMAE (official monthly GDP proxy) for May (Tue.). We expect activity to grow 2.7% year over year in May (+0.3% mom/sa). Then, the trade balance for June will also come out (Tue.). We forecast a trade deficit of USD 330 million for June compared to a surplus of USD 173 million surplus one year ago, bringing the 12-month deficit to USD 0.7 billion from USD 0.3 billion in the previous month. Moreover, Universidad Di Tella will publish its consumer confidence report for July (Tue.). The index fell by 8.2% month over month in June, after dropping 0.9% in May, and is 1.3% below the figure reported one year before. Finally, the IGA (GDP proxy published by OJF consulting firm) for June will see the light (Wed.). The IGA posted month-over-month gains of 0.3% and 0.1%, respectively, in April and May, pointing to a solid year-over-year growth rate in 2Q17 (around 3%).

Latam Macro Calendar

For details, refer to our Monthly Strategy Report.

For details on Brazilian markets, refer to our Handbook - First edition.

Today's editors: Eduardo Marza, Pedro Correa

Macro Reports


The government published its bimonthly report with estimates for 2017 primary revenues and expenditures in order to comply with the 139 bln deficit (or -2.2% of GDP).

As already announced yesterday, revisions led to an increase of 6 BRL bln of the budget freeze and to hikes in fuel taxes that should mean 10 BRL bln in extra revenues this year. This follows the net effect  of a decrease of 26 BRL bln in revenues, of 4 BRL bln in transfers to states and municipalities and a 9 BRL bln increase in mandatory spending. Hence, 2017 budget freeze now totals BRL 45 bln from BRL 39 bln in May.

Revenues 26 BRL bln downward revision reflected mostly disappointments in recurrent tax collection. Recurrent tax revenues were reduced by 25 BRL bln (due to both current and forward looking disappointments) while revenues not directly related to economic activity were reduced by 1 BRL bln.  On this front, the report took off almost 10 BRL bln with the repatriation bill and BRL 5 bln related to airport concessions and the Caixa Seguridade IPO, while included 10 BRL bln from the withdraw of judiciary deposits (or “Precatórios”). Transfers to states and municipalities were reduced by BRL 4 bln mostly due to the above-mentioned revisions on the repatriation bill collection.

Mandatory spending was increased by 9 BRL bln. This mostly reflected the recognition of fiscal costs with the FIES program. This should be offset by a much lower distortion with the official primary result (“below the line”) published by the central bank. 

In all, complying with the 2017 target remains a feasible, but also challenging task and needs the following, assuming our forecasts: 

(i) No further frustration in extraordinary revenues and taking  an especial care with the REFIS/PERT program (currently expected at 13 BRL bln). The program rules are still being debated in Congress and the rapporteur Newton Cardoso (PMDB-MG) is trying to approve a program with higher waivers of interests and fines. Ultimately, government could let the provisional measure expire, since the deadline to enter the program (end of August) is earlier than the expiration date (mid-October), but this could lead to a lower demand to the program as generates legal uncertainties. Also, there is a minor risk that the payment of the auctions scheduled to happen in September and October be delayed to 2018.

(ii) The capability to deliver a budget cut of around 40 BRL bln. Today’s cut of 45 BRL  is very likely unfeasible, but could be reduced ahead with downside surprises in mandatory expending and with 4 BRL bln that were excluded from today’s report but still might happen this year (2 BRL bln in further “Precatórios” withdraws and 2 BRL bln with the anticipation/renegotiation of Galeão airport concession). Ultimately, government could delay expenses using the so-called “restos a pagar”.

Pedro Schneider

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