Morning Note /

Latam Daily: Chile hikes less than expected, focus now turns to Banrep tomorrow

  • Talking Points: Chile raises rates by 150bp, set to release inflation report today

  • Forex: BRL keeps outperforming but leads to a rise in hedging costs

  • Fixed Income: Chilean front-end likely to be received as rate hike trajectory re-assessed

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Daron Hendricks
Kieran Siney
ETM Analytics
30 March 2022
Published byETM Analytics

Talking Points: Chile raises rates by 150bp, set to release inflation report today

Brazil: Some positive news on the labour front, formal job creation came in significantly higher than expectations in February. Data released on Tuesday showed that 328k jobs were added to the economy last month compared to expectations for a more modest increase of 220k and 150k in January. While the February jobs print is encouraging, the level of slack in Brazil’s labour market remains elevated.

Going forward, we expect labour market dynamics to remain relatively weak. Therefore, demand-side inflation pressures are expected to remain relatively lacklustre, especially given the sharp rise in domestic interest rates, which has resulted in a significant tightening in credit dynamics. While there are a number of downside risks to the economic outlook, it must be noted that the persistent rally in commodities should help underpin the recovery of the economy.

Mexico: According to official government statistics released yesterday, Pemex, the state-owned oil company, fell considerably short of its oil-refining objective last month. Specifically, Pemex processed 846k barrels per day in February, the highest level since 2017, because high oil prices were too good to pass up, with oil trading above $110. Still, this fell well short of the ambitious target to refine 1.51mn barrels per day. Note that crude oil prices have risen more than 40% since the end of December, when Pemex announced plans to curb oil exports. Major oil producers will meet on Thursday to discuss their supply policy for May. The group has signalled it will stick to its existing plan and ratify an increase of 430,000bpd in output despite crude flow disruptions due to Russia’s war in Ukraine.

Today’s economic calendar has unemployment and monthly budget balance data scheduled for release. In terms of the former, Mexico's fiscus has remained stressed at the start of the year, with a deficit of MXN58.84mn, significantly worse than the opening balance in the previous two years. Although tax income has recovered significantly at a time when interest rates and borrowing costs are low, government spending is weighing on improving budget figures. With no evidence of the government embarking on a fiscal consolidation, we can expect the government to run a substantial deficit for the foreseeable future.

Colombia: Presidential election frontrunner Petro noted yesterday during a debate that he would write off student loans provided by state-run financier Icetex. His other promises included resuming peace talks with the ELN rebels, promoting cannabis exports, and improving bilateral relations with Venezuela. Petro also promised to remove the finical transaction tax known as 4x1000, except for financial institutions. The debate didn't include conservative Candidate Federico Gutierrez or centrist candidate Sergio Fajardo, so there was no insight provided on their views on the matters discussed.

The promises made by Petro will be a major concern for investors, given how far left they lean. Writing off student debt could have major financial market implications, while trying to recover bilateral ties with Venezuela could leave Colombia ostracised by the likes of the US, given the sanctions that are still imposed on the South American nation. As we often see, however, such promises barely amount to anything once candidates who make them are elected. They are nothing more than tools to garner support ahead of the election, after which a fragmented Congress usually leads to stagnation within the government and a lack of any new radical policies being implemented. We have seen this in Mexico and Peru recently, and the same will likely occur in Chile now after left-leaning Boric won the recent elections there. If Petro wins this election, it is likely that Colombia's Congress would remain fragmented, and the executive will lack the power to enact any of these controversial reforms..

Chile: The BCCH released its first verdict on rates under the new administration yesterday. The Central Bank hiked rates by 150 bpts which was 25 bpts below the consensus forecast of 175 bpts. This was the second straight increase of 150 bpts, with the bank mindful that the economy was on a “downward path” and indicated that future rate increases are likely to be smaller than the one imposed last night. Bloomberg reported - “The Board considers that, if the assumptions in the central scenario of the March Monetary Policy Report prove correct, future increases in the MPR would be smaller than those of recent quarters. In any case, this will depend on the evolution of the macroeconomic scenario,” they wrote. The broader take-home here is that although pressures on inflation and inflation expectations remain to the topside the bank is mindful of cratering economic growth at a time when it is slowing and dynamism is fading. Today will see the bank releasing its policy report this morning which will give further insight into the bank’s thinking on growth and inflation as well as the broader direction of monetary policy going forward.

In terms of the mining sector, the new government has had its first taste of investor intentions made clear. The BHP Group yesterday stated that they would invest more than $10bn in Chile over the next 50 years but only if certain regulatory and fiscal conditions are met. Reuters reported - “We love Chile. We would like to stay here. We would like to grow in this country. But in order to do that, it will require fiscal stability, legal certainty and a clear pathway to permit,” Ragnar Udd, BHP’s president of minerals, Americas, told the CRU-CESCO World Copper Conference in Santiago. The government has stated that it has no intention to nationalise the mining sector however the level of government taxation and participation is still unclear.

Peru: Local newsflow has been a bit on the thin side following yesterday's announcements that President Castillo has survived a second impeachment attempt against him. We did, however, have former production minister and former central bank board member Kurt Burneo on the wires, stating that he sees the lack of explicit support for Fin Min Graham from President Castillo as creating a lack of coherence between cabinet policies and economic policy. This creates more uncertainty, with the Fin Min focused on preventing certain policies such as 100% withdrawal of pensions. Burneo also predicts that the survival of his impeachment will not strengthen Castillo's government as most political parties remain against Castillo, with only certain individuals being negotiated with, who could change their stance on supporting Castillo at any time. Finally, more social unrest is predicted by the former minister and central bank board member, given the rising costs of living.

We agree with all the points made by Burneo. The government's lack of coherence on economic policy remains a major red flag to investors, and will continue to generate political uncertainty. The government also remains in a place where it is unable to assert any authority when it comes to reforms, given the fragmented Congress which remains at odds even after Castillo survived his impeachment. This lack of ability to pass through any major reforms will also keep the risk of social unrest high, something we have seen in some Peru's Latam peers.

Forex: BRL keeps outperforming but leads to a rise in hedging costs

Brazil: The USD-BRL seems to be settling just below the 14.8000 mark after failing to extend its decline past these levels. For context, the USD-BRL ended the session at 0.17% lower at 4.7578, according to Bloomberg data. While the downside momentum in the pair seems to be fading, the BRL should continue to benefit from its attractive carry trade and elevated commodity prices. As mentioned in previous commentary, the BRL’s high carry and marked undervaluation have resulted in a significant outperformance of the currency relative to its emerging market peers.

While the BRL is the best performing emerging market currency in 2022, it is worth pointing out that implied volatility in the currency is rising as traders seek protection following the extended rally in the currency and as expectations for more substantial swings in the currency mount ahead of the elections later this year. .

Mexico: The USD-MXN unwound the day prior’s advance on Tuesday, and then some, to break below the psychological 20.000 support and close at 19.9149. The reversal was supported by signals of Russia’s pullback in Ukraine and the USD taking a breather from its three-week high. A continuation of yesterday’s price action would postpone the pair from entering a bull trend and instead see it challenge the 19.900 support, a break of which could see the pair test its September low of 19.8486. Much of the impetus will depend on the external environment. It remains unclear how much this improved risk sentiment will last, but the USD remains on the defensive for now.

Colombia: The USD-COP ended yesterday near the bottom of its recent trading range, sliding to 3756 by the close given the improvement in global risk appetite. Sentiment remains positive towards risk assets this morning, while oil prices are recovering a bit to add additional support to the COP. We could, therefore, see the pair break below the 3750 level and near its recent low of 3729. Traders may also look to position ahead of tomorrow's Banrep announcements, which should be supportive of the COP from a carry perspective.

Chile: It was a choppy day of trade for currency traders yesterday as traders digested the plethora of global and domestic developments. The USD-CLP hit levels as high as 784.88 and as low as 771.89 to end the session at 779.90, marking a 0.12% rise from the previous session. Looking at the session ahead, the USD has continued to fall this morning, which should provide a tailwind for CLP bulls. The smaller than expected rate hike could however offset these tailwinds.

Peru: The PEN initially firmed at the open yesterday, supported by positive developments locally and abroad. It ran into resistance at the 3.7000 level once again, however, as traders continue to see this as a good USD-buying level. The impeachment vote also doesn't change much in the way of the local political situation, which will have limited any relief rally. We expect to see 3.7000 continue to hold up unless we get some significant positive developments on the external front.

Fixed Income: Chilean front-end likely to be received as rate hike trajectory re-assessed

Brazil: The downward momentum in Brazilian bond yields persisted yesterday. Yields across the curve traded lower on Tuesday, following some positive external developments, including optimism about easing tensions between Russia and Ukraine, which resulted in a marked improvement in global risk appetite and a drop in international oil prices which helped ease inflation concerns.

The recent drop in bond yields is a sign that traders are adjusting their inflation bets following the central bank’s communication that it is likely to end its rate hiking cycle at its May meeting, where it has pledged to deliver another 100bps rate hike. Note that prior to the March 16 Copom meeting, the swap market had priced in a Selic rate as high as 13.8%. Economists, meanwhile, still expect the BCB to raise the Selic rate to 13.00% by the end of this year.

Mexico: MXN bond yields fell for the second straight session yesterday, in line with a stronger currency and lower US Treasury yields. Moreover, optimism over movement on cease-fire talks between Russia and Ukraine drove down oil prices and bond-market gauges of inflation expectations. The debate among bond traders is over the risks of a growth downturn as central banks globally begin to withdraw stimulus. This follows the US Treasury curve briefly inverting, typically a signal of an impending recession, though its accuracy is being questioned after years of hefty stimulus. The yield curve inversion needs to be sustained before it becomes a predictor of anything.

Colombia: Colombia's local currency bonds firmed again yesterday, tracking most of their regional peers as sentiment received a boost from some positive developments on the Russia-Ukraine front. The moves have taken the benchmark 10yr back below the 10.00% level, although yields are still well up on the month. There is scope for yields to slide further in the sessions ahead if we see external sentiment remain positive, which will flatten out the curve as the front-end should remain supported by rate hike expectations, especially ahead of this week's Banrep meeting.

Chile: The direction of the swap and bond market is going to be dictated by how the market digests the overnight change in interest rates and accompanying tone, coupled with the CB’s policy report due this morning. We expect that the paying pressure, especially on the short end, is likely to pare back as investors reassess the trajectory for rates. Potentially we see 2v10 dis-invert moving away from the -190 bpt handle, which has been the anchor for the last couple of days.

Peru: Local currency bonds gained yesterday, with some positive reaction to Castillo avoiding impeachment being exacerbated by risk-on trade following the positive news on the Russia-Ukraine front. Yields from the 15yr sector onwards dropped b more than 12bp on the session, flattening out the curve as front-end yields remain supported by rising inflation pressures. Should external sentiment remain positive, we could see the curve continue to flatten out over the coming sessions.