Morning Note /

Latam Daily: Commodity price surge drives terms of trade improvements

  • Talking Points: Inflation expectations continue to rise

  • Forex: Colombia’s terms of trade surges to record high, portending to some outperformance

  • Fixed Income: Payers remain in control for now, but valuations looking attractive

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

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

Talking Points: Inflation expectations continue to rise

Brazil: Unsurprisingly given the persistent rise in international oil and agri prices as the war in Ukraine intensifies, economists polled in the BCB’s Focus survey raised their 2022 and 2023 inflation forecasts further above targets. This comes on the back of domestic factors, including severe weather, which has driven bolstered domestic inflation pressures.

Specifically, economists now expect inflation to end this year at 5.60% and 3.51% at the end of next year. Recall that the central bank’s inflation target is 3.50% for this year and 3.25% for next year. While inflation forecasts were revised higher, economists kept their 2022 year-end estimate for the benchmark Selic rate at 12.25%, implying that we could see rates rise by a further 150bps in the year ahead.

Although the marked rise in inflation rates is weighing on the economy, the aggressive rate hikes have significantly boosted the attractiveness of Brazilian assets. The BRL has climbed the carry attractiveness ranks over the past year as the central bank embarked on the most aggressive monetary tightening in the emerging market space. This comes on the back of a significantly undervalued currency, solid trade dynamics and highly attractive interest rates. The combination of the above factors makes the BRL the most attractive carry destination in our view. The BRL scores 6.6 in terms of carry attractiveness.

Mexico: In Q4’s Quarterly inflation report published yesterday, the central bank cut its economic growth forecast for this year, citing the persistent uncertainty resulting from the COVID-19 pandemic. Specifically, Banxico lowered the expected growth of GDP from 3.2% to 2.4%, mainly because the marked weakness in Q4 last year led to a lower growth base for the current year than previously expected. However, the central bank anticipates the economy returning to a path of gradual growth in Q1 2021, supported by both domestic and external demand. Looking ahead, the central bank raised its growth forecast for 2023 from 2.7% from the previous estimate of 2.9%. When presenting the report, Victoria Rodriguez, governor of Banxico, said the 2022 review took into account the expectation of less fiscal and monetary stimulus in advanced economies, less mobility due to increasing COVID-19 cases and disruptions to supply chains. Regarding inflation, the central bank maintained its forecast for 2022 at 4%.

Colombia: The local data card has export figures slated for release today. The numbers may not move the markets at the moment, but will be important in providing some insight into how the economy could perform through Q1 of 2022. Exports have surged to record highs and we could see them remain elevated over the near term given the surge in oil prices that we have seen in 2022 so far, with global growth having largely held up, barring the start of the conflict in Ukraine. The surge in exports will also be looked at in terms of national revenues, a key factor to keep an eye on given Colombia's current fiscal state.

Chile: In terms of base metals, aluminium hit an all-time high this morning of $3650/tonne before pulling back slightly to trade at $3642.50/tonne going into the start of the EU session. The metal is fixated, and rightly so on the conflict in Eastern Europe and what this means to supplies of the metal. Sanctions against Russia have increased and for context, some 900 000 tonnes of Russian aluminium supply is at risk here. Stocks of aluminium at LME registered warehouses have more than halved in the last year to 809 750 tonnes compared to just under 2 000 000 tonnes last March. We expect the trend to continue which will increase price pressures.

Copper has also received a leg up clearing the $10000/tonne level yesterday, the red metal has continued to build on these gains today clearing the Feb 2022 highs. The benchmark 3m LME contract is currently trading at $10345/tonne with the Oct 2021 highs of $10452.50/tonne.

On the local mining front, SQM has posted a near five fold increase in profits driven by higher lithium prices. The world’s no 2 producer of the metal reported profits of $321.6mn in the 4th quarter versus $67.0m in the same quarter a year ago. The higher lithium prices are expected to continue as the decarbonisation of the world gains momentum. The company aims to sell 180 000 tonnes of lithium this year.

Peru: New Fin Min Graham was on the wires yesterday, suggesting that public investment in Peru could be up to 40% higher than it was in 2021. Graham did not comment on how this increase in spending would be funded. It is likely that a massive windfall from commodity prices could be used here, but investors will be watching closely to see if more borrowing will be needed in order to achieve such levels. Higher spending and borrowing could threaten Peru's sound fiscal policies and its strong credit ratings. We don't however, see this happening just yet as any major reforms or excessive spending programmes would be halted in Congress.

Meanwhile, Congress's comptroller committee will question President Castillo on 7 March in the presidential palace, according to lawmaker Hector Ventura, who heads the committee. Castillo will be investigated for alleged violations of transparency as he held private meetings outside of the presidential palace, which is illegal under Peruvian law. Some of the alleged meetings included businesswoman Karelim Lopez, who has since accused Castillo of corruption

Forex: Colombia’s terms of trade surges to record high, portending to some outperformance

Brazil: As expected, the BRL came under significant selling pressure at the start of yesterday’s session. However, the bearish impetus was not sustained, with the local currency paring its earlier losses to end the session 0.97% firmer against the USD at 5.1020m, according to Bloomberg data. Helping to underpin the recovery in the BRL was comments from Fed Chair Powell, who poured cold water on expectations of a more aggressive rate hiking cycle. The comments overnight have spurred a broad-based recovery in EM currencies this morning. Although EM FX is a sea of green ahead of the local open, risks to the outlook for EM currencies remain firmly to the downside, especially for the more fragile currencies as the conflict in Ukraine intensifies.

Mexico: After initially surging to a four-week high of 20.800 as investors flocked into safe-haven currencies in response to the Russia-Ukraine crisis, the USD-MXN finished below the 100DMA at 20.6480. The pullback followed Fed Powell’s comments that have offered some reprieve to risk assets. But with the macroeconomic backdrop still fluid and a considerable degree of market caution, the USD-MXN has continued its advance this morning. Technically, the underlying bias of the USD-MXN remains to the topside. The 50.0% Fibo retracement level at 20.8770 will be the next significant level to target, possibly propelling the pair higher to the 38.2% Fibo retracement level at 21.1785, with the 61.8% Fibo level at 20.5750 acting as strong support.

Colombia: The COP rallied sharply yesterday, outperforming its Latam peers on the day as surging oil prices supported the local unit. The USD-COP dropped below the 3900 handle and the 200DMA at 3862 as a result. The gains came alongside rising IBR swap rates, suggesting that some of the gains were a result of investors pricing in more aggressive policy tightening as a result of surging commodity prices. Looking at Citi's Terms of Trade Index for Colombia, we see that it has surged to its highest on record in recent sessions. This will go some way in providing the COP with some resilience to external shocks, and will make it an attractive proposition, especially if rates continue to rise to support the carry profile. Colombia's terms of trade is also the strongest among Latam, suggesting we could see it outperform its peers over the near term.

Chile: Looking at the 1m implied vol measure for today we see the tenor consolidating its position around the 17.50% mark after leaping higher as the conflict in the Ukraine erupted. The fact of the matter is that LATAM currencies are likely to experience less of a fall out versus other EM’s such as those in Eastern Europe so vol consolidating makes sense.

When looking at the local unit further consolidation with a slight depreciative bias as the order of the day. The USD-CLP closed just above the 805 mark with the trading day seeing a tight range once again. Not much to report back on.

Peru: The USD-PEN declined yesterday, finding support from rising copper prices and recovering global equity markets as Fed Chair Powell poured cold water on bets that a 50bp rate hike is coming this month. The pair slipped by just under 1% with the PEN outperforming its Latam peers barring the COP, closing the session at 3.750, keeping to within the range seen between 3.800 and 3.700. We could see this range hold up over the near term, given the uncertainty within the markets that are being offset by surging commodity prices. For some context, Peru's terms of trade is near its best levels on record at the moment.

Fixed Income: Payers remain in control for now, but valuations looking attractive

Brazil: Wednesday was a blood bath for Brazilian bonds as domestic markets played catch up following two days of national holidays. Yields across the curve traded higher however movements on the front-end of the curve were significantly more pronounced. Specifically, the shorter-dated 2yr yield surged 24bps on Wednesday to close the session at 12.30%, levels not seen since November. The sharp move came on the back of a spike in international oil prices as global buyers continue to shun Russian oil.

Sticking with oil, OPEC+’s announcement yesterday also did little to calm the markets, with the expected 400k barrel per day increase announced. Yesterday’s meeting ended in a record time, with no discussions being had surrounding Russia, according to sources familiar with the matter. OPEC appears to be happy to just sit on the sidelines, for now, reaping the benefit of higher oil prices and possibly higher export numbers as Russian crude will need to be substituted with that from the Middle East and other exporters. This morning oil is trading a whisker below $120/bbl, suggesting that the bear flattening bias is likely to persist.

Mexico: Mexican bonds traded flat on Wednesday, despite the release of the budget balance data and the quarterly inflation report. Mexico's state finances are in a better position at the start of the year, and while it remains to be seen if this trend persists, it may alleviate some of the fiscal risks priced in on the long end of the curve. Still, sluggish economic growth remains a pronounced risk to Mexico’s fiscus in the near term. Meanwhile, we can expect the front-end of the yield curve to remain under pressure amid expectations for further policy tightening by Banxico, but at a more gradual pace as policymakers look to foster the economic recovery while keeping a lid on prices that are rising rapidly. Banxico will remain attentive to the US Federal Reserve’s decision to raise interest rates, as the Fed remains determined to push ahead with tighter policy while keeping a wary eye on the Russia-Ukraine war and its possible implications for global economic growth. The major source of angst for policy-setters is the spike in oil prices, which has been a key driver of inflation this year owing to possible supply disruptions and strengthening demand, and is now being amplified by the conflict in Europe.

Colombia: Colombian bonds remained under a bit of pressure yesterday, but overall the upside momentum for yields seems to be stalling now. We are not out of the woods just yet, however, with global markets still on edge given the Russia-Ukraine conflict. There has been some improvement in general levels of risk appetite, which could attract some dip-buyers. As we noted earlier this week, Colombian bonds are looking very cheap at the moment, and once the dust settles on the European crisis we could see investors return to take advantage of the high yields on offer, especially as those invested in Russia will need to find a new home for their capital once they get it out.

Chile: Payers remain in control for both swaps and bonds at the moment. The bond curve saw the front end of the curve gain on average around 5 bpts on the session while the longer dates around 2 bpts. Higher commodity and energy prices are driving the inflation fears keeping the front end us the underperformer relative to the longer tenors. This is unlikely to change anytime soon so curve inversion is likely to become more acute in the coming days.

Peru: Local bonds remained under pressure yesterday, with yields rising across the curve barring the very front-end, which saw some relief from a less hawkish Fed Chair Powell. The topside pressure for yields is likely to remain entrenched for as long as the markets remain so uncertain. As we have noted before, however, we will continue to see Latam bond markets outperforming those in emerging Europe, with investors looking for safer options that are still offering a decent yield. Peru should be able to capitalize on this, given its strong credit rating.