Itaú BBA - Weekly Fixed Income LatAm Strategy: Last rate cut in Brazil, Mexico on hold
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Weekly Fixed Income LatAm Strategy: Last rate cut in Brazil, Mexico on hold

May 14, 2018

We expect Brazil’s central bank to cut rates, and Mexico’s to stay on hold.

BRAZIL: The market is focused this week on the Copom meeting and an election poll. We expect the Copom to announce a final 25-bp cut in the Selic rate on Wednesday, seeking to minimize risks of inflation converging slower to the target. In addition, a CNT/MDA poll of voting intentions is scheduled to be released from Monday onwards.

BRL depreciated (to 3.60) and local rates continued to widen last week. We have no position in Brazil today (after a good performance receiving Jan21). The market prices in higher than 50% chance that this final 25-bp cut will indeed occur, but recent BRL depreciation reduces substantially the risk that the Copom will continue to ease monetary policy after its May meeting.

MEXICO: We expect Banxico to maintain the policy rate stable at 7.50% (Thu.), as inflation is falling fast (already below 2.5% in the last three months, seasonally-adjusted and annualized) and clearly showing more benign dynamics across its components. In fact, given the Central Bank’s guidance emphasis on “inflation forecast targeting” and the high probability, in our view, of inflation undershooting Banxico’s forecasts for average annual inflation in 2Q18 we believe additional rate hikes are unlikely in the short-term.

Local rates continued to widen last week, because of (1) the tightening in global financial conditions, (2) AMLO becoming more likely to win presidency, (3) fears that his party will be able to increase representativeness in Congress, and (4) the lack of a NAFTA agreement up to now. The market now implies above 20bps in hikes over the next 3 months, and a spot nominal rate close to 7.2% in the next 3 years, which we believe is excessive.

If a NAFTA agreement is reached this week, and Banxico indeed stays on hold, we believe local rates may tighten substantially. However, although a NAFTA deal is our baseline, risks remain high. No deal this week would increase the odds of no NAFTA 2.0 deal at all, causing further market deterioration. Our receiver on the 3y local TIIE rate currently bears a 1.11% loss.

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