LatAm Fixed Income & Economics Daily, Wednesday, April 4, 2012
BRAZIL: DI curve steepens on Fed minutes and new measures for industry; strong IP helps support BRL
MEXICO: Rates decouple from UST: Banxico minutes overrule Fed minutes
CHILE: Inflation report confirms BCCh's more hawkish stance; however, it is mostly priced
BRAZIL: Industrial Policy: New Measures in "Plano Brasil Maior" — Overview and Consequences
CHILE: First Quarter Monetary Policy Report: Hikes on the Horizon
COLOMBIA: Banrep Releases Economic Report to Colombian Congress
MEXICO: Consumer Confidence Still Lacks Traction
Brazil: DI curve steepens on Fed minutes and new measures for industry; strong IP helps support BRL
Aside from the Fed minutes, the most important driver of local markets yesterday was the stronger-than-expected February industrial production figure (IP), which fueled expectations of a recovery in economic activity. The IP print came in at 1.3% sa m/m, more than double the 0.6% sa m/m consensus forecast. Although the BRL opened under pressure, testing the critical 1.836 threshold for a fourth time over the last month, sentiment changed as the strong IP number along with the new government measures helped support the BRL on the back of a better growth outlook.
The government announced several measures to support local industries worth a total of BRL65 billion, with incentives such as: (1) eliminating payroll taxes through 2013 (equivalent to about BRL12.1 billion); (2) a new capital injection from the Finance Ministry to BNDES (worth another BRL45 billion) in order to extend subsidized loan programs to December 2013; and (3) other less meaningful measures like tougher enforcement of trade rules and mechanisms to increase government purchases of locally-made products.
After the measures were announced, President Rousseff stated that she "… won't hesitate to do whatever needs to be done… [and] the government won't abandon Brazil's industry." She also pointed out that Brazil needs to increase the investment rate and that she would like to see lower interest rates and spreads in the banking industry. President Rousseff's last comments illustrate how important it is for the government to enable lower interest rates, which (the argument goes) should help support local industry (via lower financing costs and preventing further BRL appreciation) and eventually increase investment rates.
In the rates space, the IP number and the government measures had a relatively more muted impact than the one seen in the FX market, while the overwhelming driver was the release of the Fed minutes. As the document suggested that the Fed may not be willing to implement another round of QE via asset purchases (unless the economy loses momentum), UST rates sold off massively in a matter of just a few minutes. After the UST curve bear steepened (with tenors longer than 5Y widening a massive 10-12 bps), the DI curve followed with a similar move, with contracts maturing after 2015 widening 8-12 bps.
Our sense is that today's release of the March PMI services numbers as well as the weekly FX flows data may provide direction to the FX market. If the PMI print continues to show more positive momentum for the Brazilian economy (supported by looser monetary conditions), we should continue to see a more positive performance in the BRL, at least compared with LatAm peers, particularly the COP.
Mexico: Rates decouple from UST: Banxico minutes overrule Fed minutes
Local rates continued to move tighter on the back of market momentum after the dovish tone seen in the Banxico minutes, with the front end of both the MBono and TIIE curves moving to price in the possibility of a Banxico rate cut in the short term. This is quite a remarkable performance, given the massive sell-off seen in UST. The MBono curve ended up steepening, but much more modestly than its U.S. counterpart, with tenors longer than 4Y widening a modest 2-4 bps. The TIIE curve also saw widening in the 3-6 bp range in tenors longer than 4Y, with the front end starting to price in 70% of a 25-bp rate cut by the June meeting (assuming a binary scenario of either a 25-bp cut or no move).
The decoupling between local rates and UST has been even more impressive over the last eleven days, during which the UST curve has seen a massive bear steepening (front end widening 1-2 bps and long end selling-off 14 bps), while the MBono curve has actually bull steepened (front end rallying as much as 18 bps and long end tightening a more modest 4 bps).
Chile: Inflation report confirms BCCh's more hawkish stance; however, it is mostly priced
Rates markets moved higher today after the diffusion of the Central Bank of Chile's quarterly inflation report. The report showed large changes in BCCh's 2012 inflation and growth expectations (for full details, please see Chile Economics section). BCCh's expectation of December 2012 inflation expectations moved to 3.5% from 2.7% and their expectation for 2012 growth moved from a midpoint of 4.25% y/y to 4.5% y/y. In terms of monetary policy expectations, BCCh's base case for the likely level of the overnight policy rate in December 2012, as well as their expectations of the level of policy rates in 1 year time and 2 years' time all moved higher by 100 bps versus their last inflation report published in January.
In spite of the large changes to BCCh's base case, as communicated in the inflation report, the market was already trading largely in line with these levels after the publication of the minutes on Tuesday. The chart below shows the market's implied levels of policy rates. Implied inflation of 3.55% in December 2012 is also largely in line with the BCCh's view, however, their forecast for headline inflation to drop to 3% by December 2012 is certainly not in line with market pricing in which the 2y breakeven inflation trades around 3.6% and 1y1y breakeven inflation is around 3.77%. This seems to be a result of the fact that BCCh continues to see the increase in headline and core inflation more as a result of specific non-continuous factors rather than a structural phenomenon resulting from demand pressure and second round effects. In terms of the timing of hikes, the 100 bps of hikes priced over the next year are fairly evenly distributed with 50 bps of hikes in the first year and 50 bps of hikes in the second year. At current levels, we remain neutral on Chilean rates. We are looking for the pricing of more than 100 bps of hikes over the next 2 years in order to consider initiating receiver positions.
Industrial Policy: New Measures in "Plano Brasil Maior" — Overview and Consequences
As we have written in previous notes, industrial performance has been a major concern for the Brazilian government. Indeed, this sector has been the main reason for the modest GDP growth seen in the last year. The exchange rate has not only increased the competitiveness of imported products, but domestic production costs (especially unit labor costs) have been rising and it, in our view, has reduced the domestic product's capacity to compete in the market.
The government has tried to assist the industrial sector by (1) providing fiscal (and protectionist) measures in order to reduce production costs, (2) devaluing the currency and (3) protecting industry against highly competitive external sectors. Yesterday the government announced an update to the Plano Brasil Maior (Greater Brazil Plan), initially released in August 2011.
The industrial policy package announced is comprised of a series of initiatives, with a focus on temporary tax breaks for select sectors and greater availability of financing. In general, the measures can be divided into (i) tax cuts in labor intensive sectors (payroll tax relief); (ii) tax cuts for investments in infrastructure (PIS and Cofins); (iii) an increase in the control of imported goods; (iv) greater accountability in government purchases; (v) greater stimulus of export credits, and the most important, in our view (vi) the increase of resources to BNDES for the expansion of existing credit programs.
Most of the programs included in the plan are not new, and have only had their deadlines and sector targets extended and/or some increase in available funds. The sectors were selected because of their labor intensive nature and therefore these sectors are most likely to be affected in terms of competitiveness by a change in labor costs.
Overall, the government announced that this set of measures will reduce the additional cost of manufacturing by approximately R$54 billion (R$45 billion refers to BNDES) through end-2012 and approximately R$8.5 billion in the next 2-3 years, given the tax breaks implemented and/or extended in this round of measures (the measures are detailed in the table below). In the August announcement, the reduction was R$25 billion.
In our view, these measures added to easing monetary policy and gains of income, and, consequently, business confidence can help the industrial recovery from the second semester onward. However, these measures will likely not offset weak global demand and, in particular, it will likely not cause a decrease in current high unit labor costs. In sum, we believe that the measures provide some limited relief to select sectors but do not change materially the competitiveness problem of the Brazilian manufacturing sector.
Given the above, February industrial production posted an increase of 1.3% m/m, significantly above both our expectation (-0.3% m/m) and the market consensus (0.5% m/m). The previous result showed a decrease of 1.5% m/m. The increase registered this month was widespread, affecting 18 of the 27 industrial sectors. But we highlight the vehicles and extractive industries, which showed recovery in response to intense losses observed in January (in terms of categories, the recovery was concentrated in capital and intermediary goods production). The rise in intermediary goods surprised us, given the current level of concern about the industrial sector.
Nevertheless, the trend measure (which can be the 3-month rolling average) is still running at a low pace, growing only 0.1% m/m in February. So, we maintain our forecast of 2.0% industrial growth in 2012, below that of the total forecast GDP growth of 3.5%.
First Quarter Monetary Policy Report: Hikes on the Horizon
The Central Bank released its quarterly Monetary Policy Report (IPoM). The Central Bank of Chile published its quarterly Monetary Policy Report (IPoM), in which it updated its baseline scenario to the upside, as we were expecting. We believe the arguments presented in the report were quite similar to the minutes from those of the last monetary policy meeting published last Friday, thus it did not differ with market expectations. For the current year, the BCCh expects GDP to grow 4/5% (vs 3.75/4.75% in December), mainly due to a more benign external scenario and higher-than-expected growth in 4Q2011 and 1Q2011; they also corrected their year-end inflation forecast from 2.7% (headline) and 2.6% (core) to 3.5% and 3.3%, respectively, mostly due to higher food and oil prices. With respect to monetary policy and in contrast to the previous IPoM (where the BCCh was expecting a year-end stance rate of 4%/4.25%), on this occasion, the BCCh considers in its baseline scenario a monetary policy rate similar to market prices (one or two hikes in 2012), and not to economic surveys, which expect a maintainance in the reference rate of 5%. It is also important to note that the BCCh considers that the appreciation of the CLP/USD has been similar to other commodity exporting countries and the current real exchange rate is consistent with these fundamentals.
Local activity and demand has surprised on the upside, but some risks remain. According to the Chilean Central Bank, after losing dynamism in the third and the beginning of fourth quarter 2011, the economy has gained strength in the rest of the year, surprising on the upside compared with what the BCCh was expecting in December's IPoM. Thus, the 2012 GDP growth estimate range was corrected by +25 bps to 4%/5%, where the main reasons behind this decision were the surprise in previous data, and the external scenario has been less adverse than anticipated. In the baseline scenario, the BCCh expects internal demand, which is currently growing at an elevated pace, to trend down closer to tendency growth rates in the upcoming quarters because of moderation of the impulse coming from its fundamentals (labor market and financial conditions). The main risk for this baseline scenario comes from the external scenario, especially a new financial crisis in Europe and a faster deceleration in growth in China.
2012 inflation estimate was corrected from 2.7% to 3.5%. In the last few months, the CPI has remained above the BCCh's inflation target, while core inflation has converged to 3%, which is faster than previously anticipated. According to the BCCh, the normalization in core inflation is coherent with the economic dynamism, a tight labor market, the depreciation of the CLP in the second half of the year and lagged transfers from international food and oil prices. In this sense, the baseline scenario for inflation was corrected to the upside from 2.7% to 3.5% for the headline and from 2.6% to 3.3% for the core CPI. Also, according to the BCCh's view, inflation should remain above 4% until the second semester, converging to 3.5% by the end of the year and reaching 3% in 2013, while core CPI will most probably converge to 3% slower than the headline. We maintain our call of 2012 year-end inflation at 3.7% and also believe that more than some specific increases, inflation reflects demand pressures, where 70% of the CPI basket shows maintenance or an increase in prices, compared with an average of 60% in the previous months. If core inflation pressures continue growing (as has been the case in the previous three months), we could hike our inflation estimate for this year from 3.7% to 3.9%.
BCCh uses as a working assumption between one or two hikes for the reference rate. The BCCh changed its expected path for the monetary policy rate from its last IPoM, where it was expecting a 2012 year-end reference rate between 4%/4.25% and almost all risk scenarios pointed to the downside. In this report, the inflation projections are supported by a path for the monetary policy rate, which is consistent with financial prices, which contemplates one or two hikes of 25 bps from the current level (5.0%). Despite this baseline scenario, the BCCh considers that there are still some risks that could lead to the necessity of a different path, where a faster deceleration of China or new problems in Europe could imply lower rates, while the increase in oil prices because of geopolitical problems (Iran) and a higher dynamism of economic activity (especially internal demand) could mean more pronounced monetary policy rate hikes. We expect the BCCh to maintain the reference rate at its current level in the near term, changing to a more hawkish bias, if the baselines scenario continues to be valid, and increasing the reference rate twice by 25 bps during this year.
Banrep Releases Economic Report to Colombian Congress
Banrep released its economic report to the Colombian Congress, explaining the latest economic outlook in local and external contexts, pointing out the recent developments in inflation, its expectations and the economic activity. They referred to an expected economic growth in 2012 that was relatively high, which was revised to around 5.0% and would be the consequence of still strong domestic consumption. They highlighted the high levels of capacity utilization, suggesting that the economic growth settles over potential GDP, as 2011 saw cumulative economic growth of 5.9%; and the fact that consumption would be the key factor behind economic dynamism. As a result, the Central Bank has made adjustments to the interest rate in order to contain the increase in the local credit portfolios, which still maintain high growth rates.
Another aspect is the gain obtained from economic growth due to the improvement in the labor market, which hit an unemployment rate of 11.9%, whereas in the same period last year it was 12.9%. Simultaneously, the employed population increased, which acts as a credible reason supporting the recent economic dynamism. The labor market outperformance also contributed toward boosting consumption and internal demand, which mitigated the adverse external context contrasted. But it was not only consumption, but also investment that grew 16.6% during 2011.
Starting in 2012, the PCI variation has corrected and returned to better levels, hitting 3.55% YoY in February, in spite of higher combustible prices. Two items made the difference in the general level of prices — the reduction of the food prices given the end of the rainy season, as well as the tradable goods prices, which have also followed downward trends thanks to a lower exchange rate. Recall that Banrep has made successive adjustments to the interest rate, which would have had positive effects in terms of containing inflation. In addition, the PPI also set in at lower-than-expected levels, suggesting lower effects on the CPI.
The risks of higher inflation are linked to: the potential continuity of high levels of commodity prices; the growth of local credit portfolios (which also boosts consumption); and a minimum wage growth of 5.8%, which impacted the inflation of 2011 of 3.7%. Nevertheless, the Central Bank states that there is a high probability to end 2012 with an overall inflation within the inflation target range of 2.0% - 4.0%.
Consumer Confidence Still Lacks Traction
According to the joint INEGI-Banxico Index, consumer confidence in March remained practically unchanged from the previous month. Consumer confidence is now at 93.4 on a non-seasonally adjusted basis, a gain of 1.9% with respect to the same month of 2011 but a slight decrease from February, when the Index stood at 93.6.
Considering the lukewarm recovery in employment, and a stable outlook for the Mexican currency, the backdrop for private consumption remained relatively unchanged in the third month of the year. Furthermore, the current conditions index retreated 1.2% from February, and the future conditions index declined 1.3% also on a sequential basis.
However, it is worth mentioning that there is significant room for improvement as the Index remains well below the maximum levels observed in the pre-Lehman years.
Consumers remain cautious on the back of stagnation in wages, a fragile global outlook and the slow recovery in employment.
While private consumption has recovered on the back of improvements in credit conditions, stable inflation and a stronger peso, the lack of recovery in wages and the excess labor supply continue to weigh in considerably among the Mexican population.