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Weekly Fixed Income LatAm Strategy

February 26, 2018

Brazil’s DI yield curve flattened substantially on Friday after (CMN) decided to revoke resolution 4.444 from 2015.

The major macro events this week include Argentina’s central bank monetary policy decision on Tuesday (we expect no changes in the benchmark 7-day repo rate), a batch of economic activity data in Argentina, Chile, Mexico and Brazil (including 4Q17 GDP on Thursday), and Mexico’s central bank inflation report on Wednesday.

On the local rates front, we continue to receive the belly of the curve in Brazil (Jan21, current P&L: +0.81%) and the front-end in Colombia (18m IBR, current P&L: +0.04%). In Mexico, we are receiving the 3y rate, but paying the 1y rate in the TIIE curve (current P&L: +0.09%).

On the sovereign debt space, we continue to believe Argentina’s 5y CDS spread will outperform its peers (current P&L: -22bps), as approved fiscal reforms are set to improve the country’s fiscal balance. In addition, we continue to buy protection in Colombia’s 5y CDS (current P&L: -6bps), as the country’s structural fiscal challenges are mounting.

Local Rates


The DI yield curve flattened substantially on Friday after Brazil’s Monetary Council (CMN) decided to revoke resolution 4.444 from 2015, which obliged local pension funds to have a minimum maturity in their fixed income positions. The resolution was causing a “fake” demand for long-maturity bonds, because pension funds were increasing duration on a cash basis, but at the same time paying long-maturity DI rates to eliminate the risk of interest rate changes. So the resolution created demand for the long-maturity bonds, but no demand for the risk embedded in increasing duration. This created distortions in the market such as yields in the DI curve trading significantly higher than bond yields.

As the government decided to revoke the resolution, the paying pressure from pension funds on the long-end of DI rates will likely disappear. So, there was a sharp correction on the bond basis, moving fast to the left as DI rates fell stronger than bond yields. The DI curve ended Friday’s session with the belly tightening 4bps and the long end as much as 15bps. The tightening in bond yields was less intense, as expected, with the long end declining between 7 and 9bps.

We believe the annulment of resolution 4.444 may cause additional flattening of both bond and DI yields if the government decides to reduce the issuance of long-maturity bonds. The government was issuing a higher amount of long-term bonds to meet the “fake” demand from pension funds, while the “true” demand, or the demand for risk of increasing duration, was unchanged. With lower supply and the same demand for risk, rates would drop. The charts below show the strong increase in pension funds participation in NTN-Fs and NTN-Bs after resolution 4.444 (dotted vertical line).

Also out on Friday, the IPCA-15 inflation preview for February came in line with expectations, but the composition remained very much favorable, as core services and industrial goods inflation may be falling below the 2% range observed since mid-2017 (see chart). We believe the release will maintain alive the possibility of another 25-bp cut in March, although our base case is that the SELIC rate will remain at 6.75%.

The inflation dynamics also underscores that it is very unlikely that BCB will hike rates anytime this year. Core inflation is running at 2% (or lower), while the inflation targets are 4.5% this year and 4.25% in 2019. A high unemployment rate and lower inertia are set to maintain services inflation on a declining trend, while substantial exchange rate depreciation would be required for a fast pickup in tradable prices (industrial goods and foods).

The weekend news flow was focused on the preliminary movements for the October Presidential race. We highlight an interview to Folha de São Paulo newspaper by Paulo Guedes, Jair Bolsonaro’s main economic advisor and likely Minister of Finance. Guedes, a former banker with a University of Chicago PhD in Economics, defends a sharp liberal turn, with privatization of all state companies, lower taxes, social security reform and much lower fiscal spending.

Guedes’ remarks indicate that Mr. Bolsonaro’s macroeconomic agenda may be market-friendly. This reduces the uncertainty towards the election, notwithstanding the problem that the Guedes agenda would require Congressional support. Bolsonaro currently leads the polls that consider former-President Lula out of the race.

We continue to receive DI Jan21 outright (current P&L at +0.81%), as inflation remains low and election risk declines (link).


Bi-weekly CPI inflation posted 0.20%, in line with our forecast and below median market expectations (0.26%). Annual inflation kept falling, now at 5.45% yoy.

We expect inflation to decrease to 3.7% by the end of 2018 (below median market expectations of 4.1%, according to the Central Bank’s last survey). The more benign evolution of the currency will be the key driver, as the backlog of exchange rate depreciation (60% between 2014 and 2016) has probably died out and pass-through is now actually exerting downward pressure. Moreover, we see further room for the normalization of non-core inflation. Inflation for regulated/administered items is also sensitive to the currency, and non-core food inflation is standing at a very high level (10.5% vs. 10-year median of 5.6%), which will likely normalize down the road.

Meanwhile, Mexico’s ex-ante real interest rate currently stands close to 3.8%, 260bps higher than the post-Lehman crisis average, since January 2009. With growth around potential and inflation declining, the monetary policy rate should normalize ahead, but risks related to NAFTA renegotiation, Presidential elections and monetary policy in the U.S. maintain open the possibility of further hikes in the short term.

We continue to receive the 3-year rate and pay the 1-year rate on the TIIE curve (current P&L: +0.09%, link) and would switch this recommendation to an outright receiver if/when the risk events pass without significant changes in asset prices.

Sovereign Debt


The Treasury posted a primary surplus of ARS 3.9 billion in January, from ARS 3.6 billion in the same month one year before. The 12-month rolling primary balance posted a deficit of ARS 403.8 billion in January, from ARS 404.1 billion in the previous month. In terms of GDP, we estimate the deficit remains at 3.9%.

The ongoing pickup in revenue growth and a significant effort on the spending side (changes in pension-adjustment formula and effort to slash subsidies) are likely to improve Argentina’s fiscal balance going forward. We expect the government to meet the primary deficit target of 3.2% of GDP this year.

We continue to believe Argentina’s 5y CDS spread will outperform its peers (current P&L: -22bps, link).


Moody’s maintained Colombia’s sovereign debt rating at Baa2, one notch above investment grade, but downgraded the outlook to negative from stable. While the agency highlighted growth, size of the economy, quality of institutions and low external vulnerability as key points supporting the current rating, the downgrade in outlook responds to uncertainty arising from increased polarization surrounding the upcoming electoral process.

We believe Colombia’s fiscal challenges are mounting, and see some risk of the country losing its investment grade down the road. The high level of oil prices is maintaining Colombia’s CDS at compressed levels, but we also expect oil prices to decline ahead.  We continue to buy protection in Colombia’s 5y CDS (current P&L: -6bps, link).


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