Itaú BBA - Weekly Fixed Income LatAm Strategy: Keep receiving in Brazil, Mexican CPI on focus

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Weekly Fixed Income LatAm Strategy: Keep receiving in Brazil, Mexican CPI on focus

October 22, 2018

We are keeping our receivers in Brazil, despite acknowledging that there may be less upside now.

BRAZIL: Although there was some retracement on Thursday and Friday, local rates tightened substantially last week, but the long-end outperformed this time. We still believe the belly is a more comfortable part of the curve to receive. Substantial rate hikes are still priced in, especially for next year, but a wide output gap and high unemployment are set to keep inflation pressures contained, unless we see major exchange rate depreciation. The long-end is more vulnerable to domestic fiscal risks (which are still very much alive) and rising rates abroad.

Our DI Jan 21 receiver currently posts a 53bps gain, and we are keeping it, despite acknowledging that there may be less upside after the strong rally of recent weeks. The election result seems to be very much priced in, as polls have been consistent, but the market still has strong discussions about the economic team and the reform agenda, including doubts about governability. Weekend news flow was positive on that sense, with indications that some members of the economic team - such as BCB President Goldfajn and Finance Deputies Mansueto Almeida and Ana Paula Vescovi - may continue in the new government. There were also indications from members of the likely new government that social security reform will be a top priority.

Several polls will be released this week, as the second round of the election will take place on Sunday. The week will also be busy on the macro side with economic activity and inflation releases.

MEXICO: Rates continued to widen last week, as Banxico confirmed the hawkish tone in the minutes of the last meeting. The local yield curve is pricing in around 25bps in hikes in the next 3 months.

October’s bi-weekly CPI (Wed.) is a major release, because Banxico seems to be willing to implement an additional rate hike in case inflation continues to surprise to the upside. We forecast a 0.48% gain, taking the 12-month reading to 5.0%. Our forecast is around the median for the last 10 years. A headline figure significantly higher, or signs that non-core price pressures are having an impact on core inflation, could increase the chances of a rate hike.

Our 5Y TIIE receiver (FX hedged) currently posts a 42bps loss. Our base-case is that Banxico will not hike, so we are keeping the position. If inflation comes in lower than expected this week, we would expect rates to tighten.

COLOMBIA: Banrep is likely to stay on hold (Fri.), in line with market expectations, amid a still wide output gap and inflation close to the 3% target. We continue to receive the 1-year IBR rate (22bps gain), because we think the market is overpricing rate hikes next year.

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