Itaú BBA - Receive 18m IBR rates in Colombia as non-tradable inflation starts to fall - LatAm FI Trade Idea

Latam FI Strategy Monthly

< Back

Receive 18m IBR rates in Colombia as non-tradable inflation starts to fall - LatAm FI Trade Idea

September 12, 2017

We recommend receiving the 18-month IBR rate, at 4.87%.

STRATEGY TEAM:

Ciro Matuo, CNPI, ciro.matuo@itaubba.com
Eduardo Marzaeduardo.marza@itaubba.com
Luka Barbosa, lbarbosa@itaubba.com
Pedro Correapedro.correa@itaubba.com


Receive 18m IBR rates in Colombia as non-tradable inflation starts to fall

In its latest policy meeting, Banrep cut the policy rate by 25bps to 5.25%. The decision was in line with market expectations and the statement indicated the central bank will likely pause the cycle. However, two board members voted for a larger cut (50-bps) and in the press statement the central bank general manager Juan Echavarría left open the possibility of further cuts before the end of this year.

One of the main factors standing in the way of further easing is the stickiness of non-tradable inflation. In fact, headline inflation has declined considerably (to 3.9% today, from 8.2% back in May 2016) on tradable and food prices, but non-tradable inflation remains at a high 5.2% (see chart 1).
      
We believe non-tradable inflation will decline in coming months, as the economy remains weak and inertia fades. We model non-tradable inflation through inertia (headline CPI 12 month before) and the urban unemployment rate, which has been rising due to weak economic activity and is better than the full unemployment rate as an explanatory variable of the inflation dynamics. The model indicates that non-tradable inflation is at its peak today, because of inertia, and will decline considerably going forward (see table and chart 2). This should leave Banrep more comfortable to continue cutting the policy rate.

Receive 18-month IBR. We thus recommend receiving the 18-month IBR rate, at 4.87%. Although we currently expect Banrep to resume interest rate cuts in the beginning of 2018 (bringing the policy rate to 4.5%), the central bank’s communication suggests risks for a more front-loaded cycle. The IBR curve has priced in about 40bps in cuts until the first half of next year, and a positive premium from 2Q18 onwards (see table 1).




  






< Back