Morning Note /

Latam Daily: Global central banks in focus this week

  • Talking Points: Brazil likely to see another major rate hike

  • Forex: MXN underperformance may ease if external conditions improve

  • Fixed Income: Chilean swap curve inversion continues

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Danny Greeff
Kieran Siney
ETM Analytics
14 March 2022
Published byETM Analytics

Talking Points: Brazil likely to see another major rate hike

Brazil: While the BCB is set to stick to its guidance and deliver a 100bps rate hike this week, hawkish bets intensified on Friday after headline inflation trounced expectations. For context, consumer prices rose by 10.54% y/y in February from 10.38% y/y in January and above consensus expectations of 10.47%. On a monthly basis, prices were up 1.01% in February. Details from the IBGE report showed that the rise in consumer prices was broad-based, with all nine sub-components increasing on the month.

The stronger than expected February print showed that despite the aggressive rate hikes over the past year, inflation pressures in Brazil remain acute. With inflation expected to remain robust in the coming months against the backdrop of a lacklustre economic outlook, the central bank has a tough task on its hands. This has been amplified by the war in Ukraine, which has added to stagflation concerns.

The BCB’s efforts to rein in inflation are being complicated by the ongoing supply chains issues and extreme weather conditions that have hindered domestic agri production. Global supply chain and logistical bottlenecks remain significant, and the world is not entirely over the Covid pandemic, with China's zero-Covid policy coming back to bite them as they now experience a wave that they are locking down against. Were China not such a significant producer and a driver of global growth, this might not be a big problem. However, the global economy remains fragile.

Mexico: Last week Friday, Mexico released its latest industrial output data for Jan. The data beat expectations to the topside and signalled the fourth consecutive month of gains. According to the statistical office, seasonally adjusted data revealed a m/m rise of 1.0% in Jan from Dec, which translated into a y/y growth rate of 4.3%. From this data, it would suggest that supply chain bottlenecks may be starting to ease, while demand also appears to be recovering from a previously depressed position, whereby it continues to normalise.

Part of the knock-on effects of the rise in global commodity prices more broadly is evident in Mexico's scrap metal price. According to the latest Fastmarkets' assessment, prices have continued to rise, with the steel scrap No1 heavy melt price rising to MXN 8,800/tonne vs a price of MXN 8,750 a week before. The price rise is to be expected as any substitute will naturally also benefit from any supply shortage. Furthermore, there is no clear sign that it is about to reverse in the short term, with the geopolitical risk fanning supply concerns still as high as ever. Although there have been some constructive talks between Ukraine and Russia, the bombardment by Russian troops is as intense as ever. Another consideration is the demand that may stem from the US as it looks for alternative sources of steel

Colombia: In line with expectations, Gustavo Petro, the front-runner for Colombia's May presidential election, secured the nomination of the left-wing Historic Pact coalition during Sunday's primary elections. On the other end of the political spectrum, former Medellin Mayor Federico "Fico" Gutierrez stormed to victory in the country's conservative coalition on the promise of tough security policies against Colombia's Marxist guerrillas and drug-trafficking cartels. Meanwhile in the centrist coalition, Sergio Fajardo secured the nomination, albeit with much less support than Petro and Gutierrez. The primary results and voting patterns thus suggest Colombia's presidential elections in May will be very polarized with no candidate on track for certain victory, which could lead to heightened volatility in the financial markets in the months ahead.

In the Congressional elections for 108 senators and 187 lower house seats, initial results suggest Gustavo Petro's leftist Historic Pact will be the biggest gainer. It was on track to get 17 seats in the Senate, which would make it the biggest single party in the upper house but still well short of a majority. The Conservative Party was on track to get 15 seats, the Liberal Party, 15, and President Ivan Duque's Democratic Centre looked set to secure 14 seats. Such a fragmented legislature may make it difficult for any president to form a governing coalition, and could, perhaps, prevent the radical policy changes investors fear.

Chile: The new administration has officially taken their seats. The youngest ever president, Gabriel Boric took the presidential sash from former president Sebastian Pinera at the Congress building in the port city of Valparaiso. President Boric’s administration is tasked with bringing about change with many neo liberal policies of old likely to be relegated to the pages of history, the former student leader will look to creating structures which are more inclusive and equitable especially following the social devastation caused by COVID-19. “What we’re seeing here is really an historic shift, a real sign of the changing times in this country,” Al Jazeera’s Latin America editor Lucia Newman reported from outside the Senate building in Valparaiso. “[Boric] is now heading a feminist, environmentalist government that’s going to try to bring about historic social change, led by a cabinet that is mostly full of young people who don’t have much experience in government, but that certainly have big plans for this country,” Newman said.

Peru: As announced last week, Peru's Congress will debate the motion aimed at impeaching President Castillo today. The market is still pricing in for the motion to fail, but there is a risk that it could generate just enough votes to move to the next stage. This could keep traders on the sidelines into the start of the new week.

Meanwhile, BCRP Chief Economist Armas spoke on Friday following the 50bp rate hike announced overnight on Thursday. Armas noted that the indicators he has seen for February point to a continued improvement in private consumption and employment, although expectations for the economy overall are still relatively pessimistic. With this, Armas still sees the economy growing around 2.7% this year, even if growth levels start to stagnate when compared to December's levels. There are some notable risks to this growth outlook, including soaring inflation which could force the central bank to hike rates faster or by more than what it currently anticipates. Politics also has room to throw a curveball at growth, given the current divide between the executive and Congress that will unlikely be repaired anytime soon

Forex: MXN underperformance may ease if external conditions improve

Brazil: While the BRL kicked off Friday’s session on the front foot, the gains were short-lived, with the BRL closing the day deep in the red against the USD. The sell-off in the BRL came despite the acceleration in headline inflation, which bolstered bets for more rate hikes. Specifically, the BRL ended the session 1.12% weaker against the USD at 5.075%. Although the BRL ended the week marginally weaker against the USD, the broader bias in the BRL remains decisively bullish, with the BRL still the best performing emerging market currency in 2022. Looking at the session ahead, the USD has reversed some of its gains from Friday’s session this morning, suggesting that the BRL could open the new week on the front foot. That said, we remain of the view that it will take a stern tailwind to push the USD-BRL below the 5.00 mark, which has proved to be a robust level of support for the pair.

Mexico: The USD-MXN is on the retreat in a move not dissimilar to that seen in other emerging markets, including fellow liquid EM, the ZAR. The ZAR, for its part, has proved remarkably resilient due to its link to commodities, and the MXN will to some extent attract similar interest, especially with the rest of the LATAM basket performing reasonably well, all things considered. Hopefully, later this week or next, constructive news of dissipating tensions in Ukraine will prompt emerging market currencies to extend their recovery, especially if the dip in risk aversion takes place alongside commodity prices that remain buoyant.

Colombia: Strong selling pressure on Thursday and consolidation on Friday meant the COP closed last week only marginally in the green. Investors had a tough time weighing external developments such as prospective Fed rate hikes, the Russia-Ukraine war, and volatile commodity markets, against local developments such as expectations for more aggressive BanRep rate hikes and political uncertainty around the recent elections. These factors will continue to drive trade at the start of the new week, and could make for some volatile intraday price swings.

Chile: At the risk of sounding like a broken record, the local unit remains in a tight range for now bracketed between the 200DMA support level at 794.69 and the 100DMA resistance level at 820.98. The EU session has seen the USD give back some of the gains of late with the DXY trading down by some 0.25% as we head into the NorAM open. This could prompt a strong open for the CLP and perhaps a test of the 200DMA is on the cards.

Peru: The PEN initially led emerging-market gains on Friday following the BCRP rate hike on Thursday. The USD-PEN pair touched a low of 3.6735 intraday before paring its losses to end the week back above the 3.7000 handle. This 3.7000 level remains the downside support for the pair to keep an eye on as it continues to attract dollar buying.

Fixed Income: Chilean swap curve inversion continues

Brazil: Unsurprisingly, given the stronger than expected inflation print, Brazilian swap rates traded higher on Friday as the market priced in more rate hike risk. While yields across the curve traded higher, the most notable moves were on the front end of the curve. For context, the 2yr rate climbed 9bps to end the session at a fresh multi-year high of 12.87%. Meanwhile, the longer-dated 10yr rate meanwhile notched 6bps higher to close the week's final session at 12.35%.

Looking ahead, while inflation is expected to eventually slow as the economy cools and monetary conditions tighten, inflation is expected to remain buoyed in the months ahead. As such, we expect the broader flattening bias in the Brazilian swap curve to persist in the months ahead. The market is betting that Selic rates could rise above 13% as the BCB looks to bring inflation back under control.

Mexico: Compared to a week ago, the curve continues to display a flattening bias, although the extent of the move has slowed and is now largely consolidative. With oil prices nudging back down and investors looking more optimistically towards talks between Ukraine and Russia, the prospect of an end to the War is keeping investors from turning wholesale defensive. Of great interest this week will also be the FOMC decision and how the Fed will choose to respond to the twin evils of slowing growth and rising inflation. They will likely attract some criticism regardless of the decision taken, but it will be important to note what guidance they give the market..

Colombia: Colombian bonds attracted some mild demand on Friday, although this did little to unwind the losses incurred through the rest of last week. The yield curve still ended the week notably higher and somewhat flatter, owing to the sharp increases at the short end due to concerns over rising inflation in Colombia and the monetary policy response it may trigger. The market may remain volatile at the early stages of this week, with investors set to have some difficulty navigating the busy week that lies ahead.

Chile: There seems to be no end in sight as to how far the swap curve is going to invert. As we start the week, the 2v10 is quoted at -182.50 bpts with the trend still focused to the downside. Where we finish is anyone’s guess as we have no historical levels to draw comparison to, we have never been this inverted before. The last time the 2v10 was inverted was in 2008 and then we witnessed lows of -67.5 bpts.

In terms of the very front of the curve, the inversion pressures have dissipated with the 1v2 now at -82 bpts off a low of -100.25 bpts at the end of Feb. All eyes will be on the Central Bank tone at the end of the month.

Peru: There is not much to report back on in terms of local currency bond yield movements for Friday. The BCRP stuck to its previous stance regarding monetary policy, and although some may have been expecting a more hawkish tone, this kept the market unchanged in its assessment. Given what is happening with global bonds yields at the moment, the bias for local currency yields should remain to the topside for now, with tightening external financing conditions and rising inflation weighing on fixed-income. Today we may see a similarly uneventful day as local focus will be on the impeachment debate.