Morning Note /

Latam Daily: Chile passes wealth tax, government set to fight it

  • Talking Points: Brazil inflation and Colombia consumer confidence numbers on tap

  • Forex: COP returns from long weekend, PEN rally running out

  • Fixed Income: March north for Latam yields continues

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Daron Hendricks
Danny Greeff
Kieran Siney
ETM Analytics
11 January 2022
Published byETM Analytics

Talking Points: Brazil inflation and Colombia consumer confidence numbers on tap

Brazil: Market focus in the session ahead will be centred on the December inflation report. Consensus expectations suggest that headline inflation decelerated for the first time in months in December. For context, economists expect that inflation slowed from 10.74% y/y in November to 9.96% y/y in December. We expect that the moderation in fuel prices will be the main driver behind a slowdown in inflation in December as it is expected to more than offset higher food and utility prices. Investors should also keep a close eye on measures of underlying inflation. Core inflation is expected to come in between 0.65% and 0.75%, and the diffusion index is expected to remain above 65%. While inflation is seen moderating in December, inflation pressures in Brazil remain robust amid the persistent weakness in the BRL, elevated commodity prices against the backdrop of ongoing supply chain issues.

Sticking with inflation and monetary policy, economists polled in the BCB’s weekly Focus survey raised their 2022 year-end Selic rate forecast by 25bps on Monday to 11.75%. This implies that economists expect the central bank to hike the Selic rate by a further 225bps this year in an attempt to rein in inflation. Recall that the central bank raised the benchmark Selic rate from a record low of 2.00% at the start of last year to 9.25%.

Mexico: Gross fixed investment (GFI) activity in Mexico moderated in October, registering a growth of 6.5% y/y after printing a reading of 9.9% y/y in the previous month. The latest figure is the slowest growth rate over the past eight months as statistical base effects continue to abate. Looking closer at the data, spending on machinery and equipment remained relatively strong during the month, despite the high base from the month earlier after reporting a reading of 10.3% y/y in October vs 10.7% y/y in September. Meanwhile, spending in the construction sector fell sharply, coming in at 3.5% y/y, easing from 9.3% y/y in September. The level of investment activity in Mexico remains a concern, and its growth going forward will heavily rely on the nation’s third public-private investment package. Such investment will support Mexico’s economy, especially in the medium and long term, due to bottlenecks and restrictions in terms of productivity that has weighed on the economy

According to the nation’s Health Ministry, Mexico surpassed 300,000 deaths from COVID-19 last week - the fifth highest death toll worldwide - as infections rise after the holiday season, fuelled by the Omicron coronavirus variant and largely unrestricted tourism. The arrival of the highly contagious Omicron variant could hit Mexico harder than some countries since it has lower vaccination rates than the likes of the US and Europe. Nationwide, only 56% of the population is fully vaccinated compared to 62% in the US and 81% in Spain.

Mexico’s economic calendar is headlined by November’s industrial production data today. Consensus expectations suggest that industrial production gained a foothold in November, with economists pencilling in a growth of 2.4% y/y from a mild increase of 0.7% y/y in the previous month. Should such a figure be realised, it will see the sector return to pre-pandemic levels. However, the sustainability of its growth remains questionable. The evolution of the pandemic, the realignment of production chains, subdued investment and the nation’s electricity reform, will determine a large part of Mexico's production capacity and economic activity going forward

Colombia: The big news out of Colombia over the long weekend is the ratification of a law that applies 0% tariffs on imports of inputs for agriculture and livestock production and the creation of a fund to benefit small and medium local businesses. The initiative aims to lower costs for farmers and encourage the use of environmentally-friendly inputs. It may ease price pressures stemming from food inflation over the longer run, while also strengthening the ecological transition towards more sustainable agriculture. However, it is not expected to ease prevailing price pressures, meaning it will have no impact on prospective monetary policy in Colombia for the year ahead.

Heading into the new week, note that the market will have the December edition of the consumer confidence index to digest today, which is expected to show consolidation of sentiment after the improvement through H2 2021. This follows as inflationary pressures continue to hurt household balance sheets, while COVID-19 has also reared its ugly head in Colombia in recent weeks, with the daily spread rate currently at levels last seen during the peak of the pandemic in June last year

Chile: Yesterday, Chile's lower house of Congress approved a bill that funds the government-backed pension changes. However, the approval opens the door for some fresh tension between Congress and the government, as a new wealth tax was approved to help fund the scheme. The added wealth tax is 1.5% for people with capital of between $5mn and $22mn, and 2.5% for those with higher levels of capital. The funding bill will now likely be challenged by the government in the courts, as they argue that setting taxes is the role of the head of state. The rift between the government and Congress will now make it more difficult for the Pinera administration to pass through any final legislation before his term ends

Peru: According to the Ministry of Energy and Mines, investment in the mining sector came in at over $4.4bn during the period January to November. This represents an increase of over 20% compared to 2020, although that comparison should be taken with a grain of salt given what happened in 2020. What will be interesting is to see if this level of investment holds up over the coming months. Local political issues and recent ructions within the mining sector will be deterrents, while the cost of money globally will rise through the coming months, turning investors more judicious in where they place their money. To maintain healthy levels of investment growth in the sector, the government will need to balance addressing local communities' concerns with those of foreign investors.

Forex: COP returns from long weekend, PEN rally running out

Brazil: The BRL unwound most of its gains made at the end of last week on Monday as the local currency joined in on the broad-based sell-off in Latam currencies. The BRL lost 0.64% against the USD yesterday to end the session at 5.6701 as the outlook for commodities soured following a rise in COVID-19 cases in China and a stronger dollar, both of which dragged down iron ore prices, one of Brazil’s largest exports. Note that several iron ore miners have also halted operations in south-eastern Brazil due to heavy rains affecting the state of Minas Gerais. Investors fear that a prolonged outage could have a material impact on Brazil’s iron ore exports.

In the speculative market, while sentiment towards emerging market currencies has soured, the BRL was the exception in the first week of trading, with investors turning less bearish on the currency, a positive start to 2022 for the volatile Latam currency. This marks a back-to-back weekly trimming of gross shorts as the central bank reaffirmed its commitment to reining in inflation by pledging to deliver another 150bps rate hike at its February Copom meeting. It is worth mentioning that if fiscal data continues to surprise to the upside and political uncertainty eases, the BRL could stage a meaningful rebound given how undervalued the currency is.

Mexico: The MXN retraced its earlier losses on Monday to close in the green at 20.370/USD, bucking the regional trend as investors remained cautious ahead of this week’s US inflation report. Though the MXN has continued to inch higher this morning, the bulls will likely run into the 200DMA, currently at 20.275/USD, which will retain any significant moves higher. Offering the MXN support at present is the dollar’s broad weakness as investors wait for the US Federal Reserve Chair Jerome Powell to speak at a congressional hearing later in the day. The market will be hoping Powell will give clues to the timing of monetary policy tightening when he answers the Senate Banking Committee questions. Meanwhile, positive domestic manufacturing data could support the MXN, in the instance, investors respond negatively to Powell’s comments.

Colombia: The COP was unable to capitalize on a retreating USD on Friday, remaining within its recent range as it depreciated 0.45% into the weekend. Despite this decline, it still ended the first week of the year some 0.70% stronger. Its near-term bias remains consolidatory, however, with the bears likely to attempt another go at 4100/$ in the near term, while the bulls are expected to continue fighting back around that level given just how much bad news is already priced in. Note that the spotlight will be Stateside dynamics this week, with Fedspeak and US CPI data the potential catalyst for any major moves in the sessions ahead

Chile: The CLP snapped its winning streak on Monday after concerns over a spike in COVID-19 cases in China prompted a sell-off in international copper prices. The CLP was the worst-performing emerging market currency on the day, losing 0.88% against the USD to close the session at 835.92, according to Bloomberg data. Adding to the headwinds for the CLP was renewed political concerns after Chile's lower house of Congress approved the bill that funds the government-backed plan for higher pensions after including a wealth tax the administration rejects.

Peru: The USD-PEN continued with its move lower yesterday in intraday trade, dropping to a low of 3.9165 before buyers jumped into the trend, scooping up the dips to leave the pair essentially unchanged on the day at 3.934. This suggests that the pair's downside momentum may be starting to fade now, confirmed by the stochastic reaching the oversold threshold. As such, we could see USD-buyers take back control in the coming sessions.

Fixed Income: March north for Latam yields continues

Brazil: A strong flattening bias emerged yesterday as yields on the front end of the Brazilian bond curve legged higher. This came on the back of the upward revision by economists to their year-end Selic rate forecast and another notable rise in US Treasury yields. Adding to the headwinds for Brazilian bonds yesterday was the depreciation in the BRL, which underscored inflation concerns. For context, the shorter-dated 2yr bond yield jumped 18bps higher on Monday to close the session at 11.97%, its highest level since November.

Looking at the shape of the curve, while the 10v2 bond yield spread remains anchored in negative territory, it must be noted that there is still a significant amount of fiscal risk baked into Brazilian bonds. This comes despite the wave of better than expected fiscal data in recent months amid growing concerns over government spending ahead of the Presidential election later this year. With President Bolsonaro’s supportership taking a blow last year, we have already seen the president adopt a more popularist approach by pushing for the new social welfare bill, which will provide cash handouts of BRL 400 to around 17mn Brazilians.

Mexico: Inflation and monetary policy tightening concerns have intensified recently and are expected to remain a central theme this year. The fact that the US Federal Reserve might be looking to tackle inflation head-on and adopt an even more-hawkish approach has caught the market a little bit off guard, which has sent US Treasury yields soaring. Going forward, policymakers' focus will remain on inflation expectations. Mexico’s 5yr break-even rate rose by 3bps to 4.7392% yesterday, snapping its descent from the beginning of the year. This is likely in response to December’s domestic inflation reading, which remains at a 20yr high, alongside accelerating core inflation. Mexico’s monetary policy is still fairly accommodative and will require policymakers to respond more decisively to anchor inflation expectations. Meanwhile, the 10yr break-even rate was little changed on the session, trading around 4.400%, a two-month peak.

Colombia: In line with the broader steepening trend of late, the Colombian yield curve rose sharply into the weekend, with moves generally more pronounced at the long-end. The 9-year tenor led the charge, adding just under 20bps to its yield through the session. With this move, its aggregate weekly increase amounted to just under 60bps, reflecting the scale of the curve’s recent rise. There are various factors driving this topside bias for Colombian yields, including rising UST yields, inflationary concerns, expectations for monetary tightening in Colombia and abroad, and political uncertainty ahead of Colombia’s elections later this year. Although Colombian yields are now above pandemic selloff highs, the bias remains to the topside still, with a material recovery not likely until political fears and inflation concerns ease

Chile: The bearish bias in Chilean swaps persisted on Friday, with rates across the curve edging higher on the session. Underpinning the bearish bias on Friday was the stronger than expected December inflation data against the backdrop of hawkish comments from the Federal Reserve, which led to a rise in US Treasury yields. That said, while Chilean swap rates traded higher on Friday, the topside moves were capped by the marked appreciation in the CLP and the weaker than expected US nonfarm payrolls data, which helped ease inflation concerns at the margin. Movements on the front-end were modest, with the 2yr rate, for instance, ticking 1bps higher. The benchmark 10yr rate meanwhile climbed 4bps on the session. This saw the 10v2 swap spread widen to 71bps.

Peru: The march higher for Peru's sovereign yields continued yesterday, with the front-end and belly of the curve coming under the most pressure. This theme has been seen across the region, with bonds in the likes of Chile also weakening fairly sharply as a combination of rising political uncertainty in the region and tightening US monetary conditions continue to weigh. The local 2026 tenor has seen its yield rise above the 5.00% handle recently, and could be eyeing the September high of 5.2428% very soon given that there isn't much scope for bonds to recover in the near term, barring a massive downside shock for US inflation which is very unlikely.