Morning Note /

Latam Daily: Bonds and FX attractive from a carry perspective

  • Talking Points: Busy data day for Brazil, Mexico’s growth outlook revised lower again

  • Forex: Improving risk appetite suggest a positive start for Latam FX today

  • Fixed Income: Recent rise in yields makes regional bonds an attractive proposition

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Kieran Siney
Danny Greeff
Daron Hendricks
ETM Analytics
23 February 2022
Published byETM Analytics

Talking Points: Busy data day for Brazil, Mexico’s growth outlook revised lower again

Brazil: It looks set to be a busy day for domestic markets, given the plethora of economic and fiscal data scheduled for release. Kicking off with the mid-February inflation report, consensus expectations suggest that consumer price growth accelerated further in the first two weeks of this month, partly driven by a seasonal rise in school fees and a rebound in fuel prices. For context, inflation is expected to accelerate from 10.2% y/y in the first half of January to 10.63% y/y. While headline inflation is expected to quicken, we could see underlying inflation edge lower. That said, we still expect core inflation to remain buoyed at levels that will continue to concern policymakers.

From a monetary policy standpoint, despite the aggressive rate hikes over the past 11 months and appreciation in the currency, inflation remains persistently strong. This underscores the notion that the BCB will tighten policy further in the months ahead until inflation is brought back under control. In line with consensus forecasts of analysts polled in the central bank’s Focus survey, we expect policymakers to raise the benchmark Selic rate by a further 150bps by the end of the year. It is widely expected that the Copom will increase the Selic rate by 100bps at the next Copom meeting.

Mexico: Mexican analysts revised lower this year's growth forecast further to 2.10% from 2.20% previously while keeping next year’s growth forecast unchanged at 2.10%. In terms of consumer prices, the economists forecast inflation rising to 4.50% this year, up 0.1 percentage points from the prior survey at the end of January. Inflation likely accelerated in the first half of February after slowing during the past eight weeks, a recent Reuters poll showed, bolstering expectations that the central bank will continue hiking rates in line with the US Federal Reserve. In particular, the survey has pencilled in a 25bps increase to the key interest rate in the next monetary policy meeting, which is scheduled for March 24. This is more dovish than the prior meeting rate hikes as the Russia conflict lowers the odds of a 50bps rate hike in March, with Banxico and the Fed now having to tread carefully in tightening if they do not wish to exacerbate a difficult environment.

Colombia: The Colombian data card picks up today with the release of industrial and retail confidence data for January. Recent prints have generally pointed to a continued improvement in economic sentiment in the country, although the economic expansion is expected to begin showing some signs of stalling since GDP has reached pre-pandemic levels. While today's data releases hold minimal market-moving potential, they will still be interesting insofar as they help investors gauge Colombia's economic outlook and the extent to which BanRep will be able to tighten monetary conditions going forward.

Chile: The incoming Finance Minister, Mario Marcel has vowed to reduce uncertainty and to control debt levels, two factors that have been plaguing the outlook for the Chilean markets for some time. Investors are concerned about the trajectory of government finances with the new ore socialist administration taking the seat next month. The new administration comes in at a time of rampant inflation, growth which may be peaking, and election promises of more support for those in need. The incoming president Gabriel Boric was wise to place Marcel in the role of Finance Minister given his pedigree and confidence he enjoys from the broader investment community.

Marcel met with his outgoing counterpart Rodrigo Cerda yesterday and told reporters that establishing a fiscal base that allows the new government to execute its plans is priority. Bloomberg reported the following which does set the stage for how Marcel will manage the purse strings going forward - Marcel said his team was surprised by an announcement earlier in the day that outgoing President Sebastian Pinera’s administration extended a job subsidy program. He asked Cerda to avoid making last-minute decisions that involve public funds, or to give him prior notice before making such moves.

Peru: The local data calendar finally picks up today with the Q4 GDP figures scheduled for release. As we have noted this week already, monthly data for December has mostly been released and shown a fairly notable deceleration in economic growth, owing to waning fiscal and monetary support, Omicron concerns, and tightening global financial conditions. Political noise has also been a constant factor in recent weeks and will be something to watch for when the rest of the Q1 numbers start to come out. The Q4 numbers will unlikely be too market-moving, given how dated they are and what data has already been released for 2022 so far. The central bank has already suggested that the economy expanded by 13.3% y/y in 2021, and by 0.8% when compared to 2019's levels.

Otherwise, there has not been much newsflow out of Peru in recent sessions that will be market-moving. President Castillo has called on Congress to urgently debate a bill that will prevent those accused of corruption from participating in elections. Even if the debate on this is pushed forward, it will have very little implications for the markets.

Forex: Improving risk appetite suggest a positive start for Latam FX today

Brazil: Notwithstanding the risk off conditions at the start of the local session, the BRL managed to extend its winning streak to a third straight session on Tuesday. Specifically, the BRL ended the session 0.91% firmer against the greenback at 5.0598, according to Bloomberg data. As mentioned above, the solid performance of the BRL is being driven by the influx of foreign funds as Brazil continues to entice investors with attractive rate differentials. Looking ahead, with the BCB expected to raise rates further, we expect the bullish bias in the BRL to persist in the weeks ahead.

Mexico: After some whipsaw price action yesterday, the USD-MXN closed on the back foot, remaining on the better side of the 200DMA technical level at 20.3490 after briefly rallying past the level to post an intraday high of 20.3768. The pair’s move lower stemmed from Western sanctions against Russia in the midst of the Ukraine standoff, which has helped lift the sombre mood somewhat. Even so, markets are in a lull as Wednesday’s economic calendar will not offer any market-moving data, leaving investors to focus on geopolitical risks. The MXN bulls, on the other hand, have taken advantage of the better mood this morning with the USD-MXN probing the 20.2450 mark, a move lower would see the pair trade at its lowest levels since October last year.

Colombia: The COP tracked regional currencies higher as market sentiment stabilized on Tuesday, gaining 0.20% to close the session around the 3930/$ mark. The currency remains stuck in a consolidatory range, with investors reluctant to trade it lower given how undervalued it already is, but also not keen on increasing COP exposure given political risks ahead of the upcoming elections. Accordingly, it will likely remain in its current range for the time being, with some depreciation risk on the horizon as the elections draw nearer..

Chile: The USD-CLP shed ground yesterday closing at 793.04 after starting the session just ahead of the 798.00 mark. An improvement in the copper price and a consolidative USD all played a role in yesterday’s gains. Looking at the open, we expect the pair to potentially open lower with copper in the green.

Peru: The USD-PEN fell back below 3.75000 yesterday as general levels of risk aversion subsided. This keeps the 3.75000 mark as the pivot level to watch, with reports suggesting that swing traders yesterday struggled to find liquidity to unwind any of their positions. This lack of volatility may remain a theme over the coming sessions. This lack of liquidity in the market can also be seen when looking at NDFs, with the implied yield on the 3-month tenor seeing some major swings over the last two weeks. It is currently just below 2.200% but has been as high as 4.0554% just a few days ago.

Fixed Income: Recent rise in yields makes regional bonds an attractive proposition

Brazil: The undervaluation of the BRL and Brazilian bonds, together with the attractive yields on offer, has seen foreign interest for Brazilian assets rise sharply this year. US ETF data tracked by Bloomberg has shown that there has been an influx of funds into Brazilian assets this year. Brazil’s aggressive monetary policy tightening cycle, which has seen the benchmark Selic rate rise by 725bps over the past 11 months, has helped lure funds into Brazilian assets as investors become pickier over where they deploy money as the global dollar liquidity tide turns. The fact that Brazilian assets are commodity-linked against the backdrop of soaring international commodity prices is also helping to underpin the attractiveness of Brazilian assets. This comes at a time when geopolitical and political risks are driving investors out of some other emerging markets, particularly Turkey and Russia. Looking ahead, given the moderation in fiscal and political uncertainty in Brazil against the backdrop of a global environment that favours high yields and commodity-linked currencies, Brazilian assets are expected to remain a favourite amongst emerging market investors in the months ahead.

Mexico: Mbono’s were marginally offered yesterday, breaking a four-day streak of consolidation. The yield curve shifted 2bps higher from the 3-year tenor to the 30-year term, mainly due to a shift in market dynamics surrounding the Ukraine issue. When it comes to fiscal risks, Mexico has seen a further deterioration in its risk profile, based on our in-house proprietary resilience model, due to widening yield spreads, rising debt-to-GDP levels, especially short term debt to reserves. Mexico's fiscal resilience is ranked in the bottom five of our sample of emerging market economies out of twenty-two, only barely below Brazil but ahead of Chile and South Africa. We see these risks becoming more acute in the future as a result of lingering economic growth and tightening external financial conditions, which will place upside pressure on MXN bond yields.

Colombia: Colombian bonds continued to trade with an offered tilt on Tuesday, with yields rising across the curve through the session despite improving market sentiment more broadly. Moves were more pronounced towards the long-end of the curve, leading to a bear-steepening thereof on the day. This steepening was consistent with consolidation in the IRS market, as well as a continued rise in Colombian CDS rates. The former is pointing to moderation in speculative bets on aggressive BanRep monetary tightening over the coming two years, with so much on that front already priced in. The latter, meanwhile, reflects persistent political concerns ahead of the upcoming elections, and the impact of the expected outcome on Colombia's longer-term economic growth rate and fiscal sustainability. These themes will likely remain in play through the coming months, suggesting demand for Colombian bonds could remain weak for some time to come.

Chile: The appeal of emerging markets is certainly robust and the best way to demonstrate the resilience in the local bond market would be to plot the spread of the US 10yr versus the 2032 bond. The spread has compressed to 378 bpts from highs of 514.82 bpts seen in October 2021. The compression has been largely driven by a rise in the US10yr since the start of 2022 with the local 10yr bond consolidating its position around the 5.75% mark. For context the current spread is marginally higher than the 12 month average which comes in at 360 bpts so we potentially have the ability to narrow even further in the coming weeks.

Peru: Peruvian bonds firmed across the board yesterday, with yields sliding and the curve bull steepening a bit as risk appetite improved. Moves were again fairly marginal, with the 2023 tenor seeing its yield slide the most after an almost 6bp drop. Dollar bonds, meanwhile, weakened across the board with some fairly pronounced moves seen at the front end and long end of the curve. The 2026 yield has risen above 2.900% as it continues its march north. Given current market conditions, we could see the 3.000% handle tested in the near term.