Morning Note /

Brazil turns hawkish again, Chile pension withdrawals back in focus

  • Talking Points: Further pension withdrawals could fan Chilean inflation, stress its fiscus

  • Forex: CLP to underperform in AFP withdrawals gain traction again

  • Fixed Income: Regional fixed income markets to remain under pressure as rates set to rise further

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Danny Greeff
Daron Hendricks
Kieran Siney
ETM Analytics
12 April 2022
Published byETM Analytics

Talking Points: Further pension withdrawals could fan Chilean inflation, stress its fiscus

Brazil: BCB President fuelled bets for more interest rate hikes after saying that he was surprised by the stronger than expected headline inflation print last week. The central bank head said that policymakers are analyzing the inflation figures to see if it changes anything regarding trends. Campos Neto highlighted that the strong March inflation print was driven by higher fuel prices as well as surprises in the costs of goods such as food and clothing.

Interest rate bets rose yesterday with swap rates on the contract due in January 2023, which is used as a gauge for year-end interest rates, rose by as much as 22bps after Campos Neto’s comments, as investors scaled up their bets for a longer rate hiking cycle. With inflation risks skewed firmly to the upside amid soaring commodity and food prices, it is looking more and more likely that the central bank may have to tighten rates post the May meeting.

Mexico: On a seasonally adjusted m/m basis, Mexico's industrial production contracted by 1.05% in February, the first drop in five months, following an increase of 1.33% at the beginning of the year. Mining and construction fell sharply, more than offsetting gains in the manufacturing sector, which has been robust to global supply chain disruptions. On a y/y basis, industrial production increased by 2.5% in February, but this was lower than expectations and the 4.3% increase in January. While part of the decline in the y/y figures can be attributed to base effects, it points to a challenging path toward the recovery of the sector. Overall, this data is bad news as it indicates that Mexico’s industrial production was already falling in February when the war in Ukraine had only just begun. Furthermore, the sharp decline in global industrial confidence indicators since the start of the war suggests that industrial production will deteriorate even further in March. This implies that industrial production may contract in the first quarter.

Taking a look at one of the few inflation drivers at present, the FAO Food Price Index hit a fresh record high of 159.3 points in March, up 12.6% from February, as the war in Ukraine reduced supply and soaring energy and fertiliser costs continue to weigh. According to FAO, the most significant price increases were reported for cereals due to a surge in wheat and coarse grains prices, followed closely by vegetable oils. The combination of high energy and food prices and interest rates will continue to squeeze households' disposable incomes, which threatens Mexico’s economic growth outlook. Today’s scheduled release of ANTAD same-store sales for March will likely highlight these variables eroding demand dynamics and shifting consumption patterns.

Colombia: Consumer confidence statistics released yesterday reflected another decline in demand-side sentiment in March, with the consumer confidence index falling to a new multi-month low of -17.5 to -17.8. Interestingly, while the consumer expectations subcategory dropped, the economics conditions subindex rose slightly, albeit from a very low base. These dynamics reflect the impact of high inflation and BanRep rate hikes on household balance sheets, and suggest consumers don't expect a reprieve anytime soon. Note that the index's decline is also consistent with broader expectations for Colombia's economic expansion to lose some momentum in the coming months following a remarkable recovery last year.

Chile: Discussions yesterday at the Chamber of Deputies centred around another withdrawal from pension funds to underpin the economy. We stated vigorously at the first withdrawal that allowing it was akin to opening Pandora’s Box, and it has caused massive dislocations in both the economy and financial markets.

Private pension funds have been long been the target of the broader population and one of the key factors leading to the unrest which started in October 2019 and involved over 1.2mn people. Thus, they don’t have much of a shield when targeted. The fact of the matter is that more than 4mn people now have a zero balance and any additional withdrawals could push this number to as high as 5.8mn Chileans.

This will undoubtedly place the longer term fiscal resilience under pressure as either higher taxes or greater levels of debt will be needed to fund the shortfall in retirement funding.

Equally, the Finance Minister Mario Marcel has stated that an additional withdrawal could cause an increase in the annual inflation rate of up to 5% while Central Bank governor Rosanna Costa warned that inflation could reach 15% by mid-year. Something that the economy cannot tolerate given that there are additional inflationary pressures in the form of higher commodity prices already baked into the macro backdrop.

Peru: President Castillo has vetoed a contentious bill from Congress that would have suspended sales taxes on luxury food items. Lawmakers said yesterday that they would modify the bill after it came under scrutiny from PM Torres. The veto of the bill may help Castillo claw back some support from the poor of the country, following polls that have shown his approval rating plummet in the aftermath of the recent protests. Castillo's government is rejected by 76% of respondents to the Ipsos poll, while 63% said that they believe that the president should resign. These are record numbers for the pollster in this regard, highlighting the struggle that Castillo will have to keep his position going forward.

Speaking of which, Congressional President Alva has said that lawmakers are willing to call for an early general election. The Ipsos poll showed that 20% of respondents believed that the government is doing a better job than Congress, while 12% believe the opposite. With such numbers, an early election could be on the cards relatively soon and will keep investors wary of the current political backdrop within the country.

Forex: CLP to underperform in AFP withdrawals gain traction again

Brazil: It was a consolidated start to the week for currency traders, with the USD-BRL trading in a relatively tight range. Specifically, the USD-BRL ended the session marginally lower than Friday’s close at 4.6967. Looking at the session ahead, the USD has continued to trade higher, which should continue to limit the gains in the BRL. That said, a surprise in the US CPI print will almost certainly result in some fresh price action for the USD-BRL.

Mexico: The USD-MXN bucked the broader trend across emerging markets yesterday, retreating for the third consecutive session, defying US Treasury yields and USD gains. The pair settled at 19.9407 after slipping below the key 20.000 support, which points to further losses for the USD-MXN if it can break below the 19.800 barrier in the coming sessions. The pair has continued with its bearish bias this morning, even though the USD remains bid ahead of the US CPI print due later today. From a technical perspective, the USD-MXN stochastics are on the verge of issuing a death cross formation, which would support a more bearish outlook. However, the fact that the 200DMA is trading flat means that the bearish bias is unlikely to be particularly significant. As a result, we cannot exclude a potential rebound in the coming sessions. Note that the MXN is close to returning to its fair value on a weighted trade basis after being undervalued for much of the year.

Colombia: The COP led regional currencies higher at the start of the week, appreciating 0.40% through yesterday's session despite falling oil prices on the day. With this move, the COP broke back below the 3750.00/$ mark, suggesting the bulls potentially still have the wind at their backs despite last week's volatility. Today, the COP may trade at the mercy of the USD, however, with the market's focus set to be fixed on Stateside inflation numbers their impact on prospective Fed policymaking.

Chile: The local unit was under pressure from the get-go with a lower copper price and uncertainty surrounding the outlook for the constitution rewrite and the potential for another round of AFP withdrawals all adding negatively to the overall sentiment. Given this backdrop, it is not surprising to see the CLP being the underperformer amongst its peers. The CLP has shed 3.9% on the month, while the likes of the BRL have appreciated by just short of 1%. We remain buyers on any USD-CLP dips with a close above the 100DMA at 817.83 almost a given.

Peru: The USD-PEN is holding steady just above 3.7000 at the moment, while keeping to within its broader trend as the downside is capped by the 3.6500 mark and the topside is contained by the 50DMA at 3.7526 currently. We could, however, see this resistance level tested in the coming sessions, especially if today's US CPI numbers come out strong and keep the USD supported. Given the current local backdrop, however, we could see liquidity levels thin out, especially given the holiday-interrupted trading conditions that we have over the next few days.

Fixed Income: Regional fixed income markets to remain under pressure as rates set to rise further

Brazil: Brazilian bonds joined in on the broad-based sell-off in bonds yesterday as the combination of mounting global inflation fears and comments from BCB President Campos Neto weighed. Yields across the curve traded higher, with the 10yr and 2yr yields climbing 7bps and 22bps to 11.97% and 12.81%, respectively.

The sell-off in US Treasuries has persisted this morning ahead of data that is expected to show that headline inflation in America accelerated at the fastest pace in 15 years in March. Inflation in the US is expected to have accelerated further in March as the war in Ukraine compounded external price pressures. Consensus expectations suggest that headline inflation rose to 8.4% y/y in March.

With inflation pressures set to remain robust in the months ahead, the Fed has turned decisively more hawkish in its communication. In addition to another rate hike, it is widely expected that the Fed will announce the start of its balance sheet reduction at its May meeting. The big question for traders heading into the May FOMC meeting is whether policymakers decide on a 25bps or 50bps rate hike.

The sell-off in US Treasuries has spilt over into bond markets across the globe, with yields in developing and emerging markets on the rise this morning. With the professional market pricing in more than 220bps worth of US rate hikes for the rest of the year and inflation risks still skewed firmly to the upside, we expect the broader bearish bias in the international bond market to persist in the weeks and months ahead. That said, we are still of the view that market bets that the Fed could tighten by 50bps at each of the next two FOMC meetings are overdone, given the emergence of renewed growth concerns.

Mexico: Mexico’s TIIE swap rates climbed across the curve on Monday, extending multiple days of gains as traders ramp up bets on higher inflation and more aggressive monetary tightening by Banxico. The 2yr swap rate has risen by more than 18bps over the past three months as pressure mounts on Banxico to follow the more hawkish tone from the Federal Reserve. According to Bloomberg data, Mexican swaps are pricing in 285bps in interest rate hikes through the end of the year, indicating at least five more half-percentage point increases.

Colombia: The Colombian yield curve bear-flattened notably at the start of the week, with short-end tenors coming under greater selling pressure than their long-end counterparts. This move likely reflected bets that tightening global financing conditions may force BanRep's hand into hiking interest rates more aggressively than it is currently signalling, as it was consistent with a payer bias in the IRS market through the session. Looking ahead, the spotlight will fall on the highly-anticipated release of US inflation stats today, which hold the potential to drive US Treasury yields higher and narrow the yield spread between Colombian and US bonds. A high print would add topside pressure to both the short-end and long-end of Colombia's yield curve, with investors increasingly betting on a front-loaded global monetary tightening cycle to combat inflation, with this set to weigh heavily on economic growth and potentially trigger a recession.

Chile: The inversion trade is back on in full swing as the 2v10 swap spread cleared the -130 bpt level overnight. The market is testing the Central Bank’s call on a more dovish approach to monetary policy as inflation runs wild and the threat of higher inflation levels remains embedded in the outlook for now. This will keep the paying interest anchored across the curve but certainly more acute in the near dates. What will be interesting to see is how the market has recalibrated its thoughts in the Central Bank Economists survey due later today.

Peru: Local government bonds kicked off the new week on the defensive once again, with yields rising across the board as global fixed income markets remained under pressure owing to growing inflation and policy tightening concerns. Yields were up more than 5bp across the curve yesterday, and we could see this pressure persist today if we get another shock CPI reading out of the US. Even if the numbers come out softer than expected, we may still see bonds remain under pressure, given that it will take a lot for the Fed to alter its current policy course.

Meanwhile, CDS spreads have widened out in recent sessions with the 5yr benchmark at 95.6bp, well up from around 77bp at the start of the month. Investors are clearly getting a bit anxious given the tightening of global financial conditions as well as rising political and social instability within Peru.