LatAm Fixed Income & Economics Daily, April 2, 2012
STRATEGY: Dovish Banxico Minutes Trigger Rates Rally; PMI May Provide Boost for BRL
MEXICO: Banxico minutes excessively dovish; first 2Q12 auction
BRAZIL: PMI to show a strengthening recovery, providing a short-term boost for BRL
CHILE: BCCh board sees a change to the balance of risks in Chile and abandons its accommodative stance
BRAZIL: Primary Surplus in February, In Line with Expectations
CHILE: BCCh to Remain on Hold in April
COLOMBIA: New Royalties General System Instituted; Employment Increases
Dovish Banxico Minutes Trigger Rates Rally; PMI May Provide Boost for BRL
Mexico: Banxico minutes excessively dovish; first 2Q12 auction
The Banxico minutes published on Friday had a generally dovish tone regarding the external backdrop, as the document pointed out that there is still no definite solution in Europe, while recent measures have been only temporary. Banxico recognizes the improvement in the U.S. economy at the margin, but still sees structural vulnerabilities preventing a stronger recovery. In fact, Banxico expects a loss of momentum in U.S. activity due to fiscal consolidation and slower exports (due to weakening global demand). Bottom line, the board sees a generally disinflationary external backdrop, but with a small caveat, which is the double risks presented by high oil prices: to the downside for growth and upside for inflation. However, the global growth outlook improved at the margin.
Regarding Mexico activity, the minutes suggest that growth slowed in 4Q11 compared with previous quarters, while weakening demand from the U.S. is starting to affect exports at the margin, which in turn is affecting industrial production. One interesting comment, however, is how there is a decoupling in some sectors. On the one hand, the performance of exports, industrial production and related services (transportation, mail and storage) is weakening. On the other, services associated with internal demand have remained resilient and even accelerated in 4Q11. In any case, Banxico expects to see a gradual transmission from externally-driven sectors and services to internal-demand related sectors, which is quite a dovish assessment, in our view. That said, the minutes also showed that a majority of members believe the risks to growth in Mexico had improved.
On the inflation front, Banxico sees no demand side pressures, as the labor market shows slack and productivity remains on an uptrend, while unit labor costs continue to fall. In fact, a modest slowdown in activity helped widen the negative output gap. The Central Bank emphasized that it feels comfortable that all CPI expectations measures are anchored and well inside the higher half of the 2-4% inflation target range. Banxico believes that the upside risks to inflation have subsided, as the threat of a financial shock has diminished, and the prevalence of drought conditions has fallen. The minutes also point out that the downside risks to inflation have increased, as the risk perception of the Mexican economy has improved, while the weakening of internal and external demand drivers still remain a threat. Overall, a majority of the members of the board believe that the risks to inflation have improved, while a minority thought it had not changed.
In our view, the minutes are sounding far too dovish, particularly given that internal demand indicators seemed to be on a positive trend. Although Mexico is certainly dependent on the U.S., it does not have the same structural weaknesses and distortions of its larger northern neighbor such as leverage or housing overhang. If anything, Mexico is now like Brazil a decade ago, as credit as a percentage of GDP is a meager 20%, which leaves plenty of room for a credit-driven cycle to play out over the next few years, as long as consumer confidence remains supportive. Sound macro polices, solid external and fiscal positions, a strong banking sector and rapidly growing exports to non-U.S. markets suggest that Mexico may outperform the U.S.
In our view, healthy job creation (see IMSS insured workers in the chart above) as well as a persistent recovery in retail sales suggest that Banxico does not seem to have any room left to cut rates. We believe that the Central Bank risks losing credibility with the current dovish stance, given that inflation may test 4.2% by 2H June (per our local Economics team's forecasts).
The rates market reacted to the dovish tone with a rally across most tenors and curves, with the MBono curve tightening 5-8 bps at the front end (less than 4Y) and a more modest 2-4 bps in longer-dated tenors (more than 5Y). The IRS market was even more sensitive to the surprisingly dovish tone seen in the minutes, with the TIIE rallying 5-10 bps at the front end and 4-7 bps at the belly.
We continue to believe that the most reasonable strategy in Mexico rates for now is to pay the front end of the curve, as the current dovish tone is inconsistent with the recovery in internal demand, which, at some point, should start to exert upward pressure on inflation expectations and some CPI components, especially combined with a relatively weak MXN. We are setting a stop loss of 4.90% for our 2Y TIIE payer trade (opened at 5.02% on March 2).
Today there will be two important releases that may move both the rates and FX markets: the March IMEF (PMI-like number) manufacturing and non-manufacturing indices are likely to show a relatively strong reading for Mexican activity (consensus points to 55 for the manufacturing component and 53.4 for the non-manufacturing one, which would mean an increase of about one point for each, or an acceleration in economic expansion) and the February remittances should also show a higher print of about US$1.8 billion (both the consensus and our local Economics team have penciled in a similar forecast), compared with the US$1.5 billion seen the previous month.
Finally, in the first auction of 2Q12, the Ministry of Finance (Hacienda) will be offering UDI600 million in 30Y UDIBonos (higher than the UDI500 million offered in 1Q12) and MXN4.5 billion in 20Y MBonos (higher than the MXN4.0 billion offered in 1Q12). There should be good appetite for both bonds, especially the MBono issue from offshore players. Local institutional investors, particularly AFORES, have been largely on the sidelines over the last few weeks despite the abundant cash levels, preferring to focus their investment strategy on local equities, with the IPC Index reaching an all-time high last Friday.
Brazil: PMI to show a strengthening recovery, providing a short-term boost for BRL
Despite the fact that Friday was the end of 1Q12 and external markets were quite benign (equity and commodity markets posted reasonable gains and UST rates widened), market price action in local markets was relatively muted. The absence of intervention-related comments from officials probably helped placate investor concerns.
The most important drivers today will be the release of the PMI manufacturing and trade balance for March as well as the weekly Focus survey. The PMI and Focus may exert a modest upward pressure on rates as the former may come in on the strong side, while the latter should continue to show relatively high CPI expectations. The FIESP (S?o Paulo Industry Federation) calculates a proxy index of the actual PMI called the FIESP sensor (there has been a strong relationship between the PMI and FIESP sensor as shown in the graph below), which was released on Friday and showed a quite strong reading that suggests acceleration in activity. If the PMI and the trade balance come in on the strong side, we could see a positive performance of the BRL. We continue to foresee a tactical rebound in the BRL against other LatAm currencies in the short term, and target 1,050 for the BRLCOP.
Chile: BCCh board sees a change to the balance of risks in Chile and abandons its accommodative stance
The publication of the minutes from the Central Bank of Chile's March meeting led to a large move higher in nominal rates and breakeven inflation, with rates nearly retaking the levels they were at before the August global fixed income rally. Tenors beyond 1y sold off by 12 to 15 bps and breakeven inflation moved by similar amounts. The move in rates caps a 110-bp move higher in the 2y swap rate since the BCCh's surprise cut in January.
At the crux of the move was the shift in the March minutes, which confirmed that the decision to cut in January was a one-off occurrence and that the majority of board members had now eliminated completely any chance of continued cuts in the near term. On the contrary, a few board members mentioned that in the future the Central Bank may need to adopt a more hawkish stance and that hikes might be necessary. In general, their view was that for the time being the best approach was a neutral ?wait and see mode?. No one on the board officially proposed any other action than maintaining rates unchanged. However, one member of the board felt that in the absence of deterioration in Europe, the board should adopt a more restrictive policy bias, meaning that hikes may be on the table in the future. Another board member said that he was worried about inflation's slower-than-expected convergence toward target and the effect this may have on inflation expectations, which would require a!
?reaction? from the Central Bank in order to contain it.
Rates markets, which were pricing about 35 bps of hikes over the next year prior to the publication of the minutes, are now pricing nearly 50 bps of hikes. Our sense is that the downside to rates in the front end is limited in the absence of any larger external weakness and that the curve will continue to price either rates unchanged or the possibility of hikes. Upside from here would be limited by the fact that while the Central Bank of Chile may adopt a more restrictive stance, it is hard to envision them initiating a prolonged hiking cycle. Therefore, current pricing, which looks to be in line with our Economics teams' forecast for monetary policy, looks appropriate. However, we would not be surprised to see rates continue to move higher in the near term, though we think that the board's tougher stance on inflation, as expressed in the minutes, may contain breakeven inflation from moving much higher, especially in the longer tenors.
Primary Surplus in February, In Line with Expectations
The consolidated result of the public sector in February recorded a primary surplus of BRL9.5 billion, in line with our forecast. This was the best result for February since the series began in 2001. Analyzing the breakdown, the central government contributed with a surplus of BRL5.3 billion, regional governments with BRL5.1 billion, and state companies with a deficit of BRL872 million.
With this, the accumulated surplus for the previous 12 months reached BRL138.6 billion, or 3.33% of GDP. In the first two months of the year, the surplus reached BRL35.5 billion, or 5.38% of GDP, which is 1.35 percentage points above the result obtained in the same period in 2011. This current trend suggests that the government will not face further problems in achieving the 2012 target (3.1% of GDP).
The nominal result, including the primary surplus and nominal interest rates, recorded a deficit of BRL8.8 billion in February. In 12 months, the nominal deficit reached BRL97.6 billion, or 2.34% of GDP, below that which was registered in the previous month, BRL100.1 billion (2.41% of GDP).
The public sector net debt increased again to 37.5% of GDP. According to the Central Bank, the debt rose by 1.1 percentage points this year due to ownership of nominal interest, the effect of exchange rate appreciation of 8.9% in the year and the incorporation of other debts, even though the primary surplus acted in the opposite direction.
BCCh to Remain on Hold in April
BCCh to remain on hold in April, but the chance of a change of bias in the future is increasing. The BCCh published the minutes from the last monetary policy meeting (March 15), which we believe is more hawkish than the market was expecting. For the first time in many months, the only alternative analyzed by the BCCh was to leave the reference rate unchanged at 5%, mentioning that although recently it was considering the option of another cut, that option could now be easily discarded. Regarding the international environment, the outlook of the BCCh is more positive, although it mentions some risk from a deeper deceleration in the Chinese economy and a rebound in the European financial crisis. Locally, it mentions that economic activity has not decelerated as they were previously expecting, internal demand continues to grow (February retail sales accelerated the most in 8 months), the labor market remains tight, wages are still in a positive trend and consumer confidence con!
tinues to trend up. With respect to inflation, all counselors showed more concern about the inflationary environment, especially the pick-up in core inflation, where there are upside risks coming from the increase in oil prices having second round effects, higher dynamism in the economy and the potential effect of drought, which is currently affecting a significant part of the country, on food prices. Finally, it is important to highlight that two (of five) counselors believe that although it was too early to change the communication, if the European situation does not fall off, this could mean a more restrictive monetary policy bias. We expect the BCCh to maintain its ?wait and see? stance in upcoming months to watch for any delayed impact of the monetary policy and for the effects of the international environment on the local economy (especially internal demand). We are expecting the BCCh to increase the reference rate twice (25 bps each time) in 2H2012, reaching 5.5% in !
The unemployment rate reached 6.4% in the February moving ending quarter. According to The National Institute of Statistics, unemployment dropped to 6.4% in the moving quarter ended in February, from 6.6% in the previous one. This figure was below our call and market consensus of 6.7% and is the lowest figure in five years. Workers increased by 3.2% y/y, boosted by commerce and manufacturing, while the wage-earning component, which affects in a greater way private consumption, increased 5.4% y/y in February's moving quarter, accelerating from the previous ones.
New Royalties General System Instituted; Employment Increases
Last Thursday, the new Royalties General System (SGR) was instituted with the first session of its steering committee. The SGR seeks to distribute the resources generated from the tax collection of the mining and oil production sectors in the most efficient and equitable manner among 98% of Colombia's towns and regions. Previously, 80% of these resources were distributed only among eight of the 32 regions of the country. The aim of this system is to promote the development of the regions through social investment projects and programs with high impact, as well as a more transparent use of the royalties' resources, which amount to COP9.1 trillion for 2012. In this first meeting, the following was approved: the operation of the steering committee and items related to its governance and an extraordinary meeting in two weeks to approve budgets for the producer towns. A detailed schedule of meetings for the next six months was made in order to approve the utilization of such reso!
urces. The steering committee is composed of the Finance Minister, the Mining and Energy Minister, the DNP Director, 2 regional Governors and 2 Mayors of two producer towns.
The DANE released information pertaining to the labor market for February, revealing an annual decrease in the unemployment rate from 12.9% in February 2011 to 11.9% in the same month this year. The employment rate (Employed/Working Age Population) was 56.7%, 2.3 pp higher than the same month last year (54.4%). For the moving quarter from December 2011 to February 2012, the unemployment rate was 11.4%, whereas for the same period one-year ago, it was 12.5%. In that period, the sectors that saw the greatest increase were: financial intermediation; mining and quarries exploitation; and water, gas and electricity services, which jointly varied 17.9% YoY, and were followed by construction with 17.5%. The major participating accounts were commerce and restaurants (26.8%), followed by services (18.3%), agriculture (18.2%) and manufacturing (12.8%). The major contribution to the change of the moving quarter December 2011 to February 2012 was made by commerce and restaurants (1.6 p.!
p.), construction (1.0 p.p.), services (0.9 p.p.) and agriculture (0.7 p.p.).
* Brazil: Despite the attractive carry, more neutral positioning and relative strong FDI, the escalating intervention response and weaker China growth prospects should push the BRL weaker toward 1.9. The BRL is likely to underperform most LatAm and EM peers as it will be dragged by aggressive easing, modest prospects for commodities and aggressive FX intervention.
* Mexico: Although we like the MXN on fundamental grounds, the peso may suffer in 1H12 from a fragile external backdrop and the electoral cycle given the currency's high beta status and low FX intervention risks. We expect the MXN to breach the 13 mark in the short term as uncertainty returns and EM proxy hedging via USD/MXN starts once again.
* Chile: The BCCh has the policy flexibility to respond rapidly to deterioration in the global economy. Therefore, we view curve steepening as a defensive trade with good upside given Chile's relatively flat front end. The CLP should also outperform in a muddle-through scenario in which China is able to avoid a slowdown.
* Colombia: The COP's low beta nature will allow it to outperform in a deteriorating risk environment and underperform slightly when risk markets move stronger. The term structure of rates is the steepest in the region, especially in the front end. We believe this steepness is unwarranted and front-end TES provide good value.
* Peru: Weaker fundamentals including the first trade deficit in almost three years will begin to put pressure on the sol, which is still trading range bound as the Central Bank intervenes against local corporates buying soles to pay taxes. Volatility-adjusted carry has come down significantly.
* Argentina: We expect significant adjustment in ARS through end-2012 of around 20%, based on increasing BoP tensions. EMBI spreads near 900 bps appear a bit high, but not so on a risk-adjusted basis, given elevated EM and domestic policy uncertainty.