Itaú BBA - Receive Colombian 18m IBR rates again as yield curve prices in almost no rate cuts ahead – Local Rat

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Receive Colombian 18m IBR rates again as yield curve prices in almost no rate cuts ahead – Local Rat

February 1, 2018

Despite the board’s hawkish message, we see room for additional easing ahead.

We took profits on our receiver position in the front end of Colombian local rates back in December 2017 (link) as the yield curve had priced in that rates would be cut to 4.0% by the end of the easing cycle, matching our scenario.

Earlier this week, Banrep cut the policy rate by 25bps to 4.50% and, surprisingly, indicated in the statement that the cut brings the easing cycle to an end. After the statement, yields in the front end increased substantially. Now the curve prices in only 15bps in rate cuts in the next 6 months and, after that, 30bps in hikes in the following 6 months.

Despite the board’s message, we see room for additional easing. In our view, the monetary stimulus in place is mild given the weakness of the economy. This, alongside inflation that in our view will fall towards the target in 1Q18 and anchored inflation expectations, support our call that the policy rate will reach 4.0% by yearend.

The still-high level of non-tradable inflation seems to be bringing some caution to Banrep, but we believe it will start to decline soon, 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 close to its peak today, because of inertia, and will decline considerably going forward (see chart 2 and table 1). This should leave Banrep more comfortable to continue cutting the policy rate. In addition, we see little risk of another pickup in tradable prices, given a favorable global scenario for emerging markets, and a more a ppreciated COP.

We see two risks for our trade. The upcoming Presidential election is a risk that could bring exchange rate volatility (putting pressure on the tradable component of inflation). In addition, the favorable global scenario, including higher oil prices, creates risk of economic activity picking up more rapidly than we expect. But we note that the negative output gap means the recovery would have to be very strong to trigger rate hikes in the near term and therefore limits the downside to our trade proposal.

We thus recommend receiving the 18-month IBR rate at 4.56%, as we believe this rate will shift lower going forward. The trade earns a small positive carry of 0.2% in annualized terms. For cash investors, we recommend going long on bonds with similar durations, such as the Coltes September 2019.


MACRO TEAM:
 

Mario Mesquita - Chief  Economist
Fernando M Gonçalves, fernando.goncalves@itaubba.com
Luka Barbosa, lbarbosa@itaubba.com
Eduardo Alonso, eduardo.marza@itaubba.com

João Pedro Buchamar, joao.resende@itaubba.com 
Miguel Ricaurte,
miguel.ricaurte@itau.cl 
Vittorio Peretti,
vittorio.peretti@itau.cl



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