Talking Points: BCB hikes and signals more to come
Brazil: The BCB raised the benchmark Selic rate by 100bps to 11.75% last night, in line with expectations. The big surprise was that the central bank pledged to deliver another increase of the same size at its May 4 meeting while also opening the door to more rate hikes if the commodity shocks persist. Last night’s move means that the BCB has increased rates by 975bps over the past 12 months, making it one of the world's most aggressive Covid-era hiking cycles.
The Copom said in its statement, “If those shocks prove to be more persistent or larger than anticipated, the Committee will be ready to adjust the size of the monetary tightening cycle.” Reiterating that it remains committed to reining in inflation, the BCB said, “the Committee emphasizes that it will persist in its strategy until the disinflation process and the expectation anchoring around its targets consolidate.”
We assess the overall tone of the policy statement as decisively hawkish, particularly after the committee mentioned that it would deliver another 100bps rate hike at its next meeting. The hawkish statement and forward guidance imply that the benchmark Selic rate will end the year above the 13% mark, especially if international commodity prices remain elevated..
Mexico: According to a report published by the World Bank yesterday, Mexico should implement a series of reforms to boost the nation’s low productivity. It said the need for change was "more important than ever" as the COVID-19 pandemic exacerbated long-standing structural challenges to growth. In February, central bank member Jonathan Heath similarly said that Mexico lacked a "growth engine" and that private investment needed to be increased to support economic growth. The financial institution advocated an end to market concentration in Mexico, claiming that while major firms wield much of the country's economic power, they do not grow rapidly enough or generate enough jobs.
In an accompanying event in Mexico on Wednesday, the country's Deputy Finance Minister Gabriel Yorio said that the hit to global value chains initially caused by the COVID-19 pandemic would likely be prolonged due to Russia's recent invasion of Ukraine. This is on top of China's zero-Covid policy returning to bite them, as they are currently experiencing a wave of infections that they are attempting to contain with fresh lockdowns. If China were not such a key manufacturer and engine of global growth, this would be a lesser risk. Nonetheless, it exacerbates the headwinds that Mexico's fragile economic recovery is currently experiencing
Colombia: According to Santiago Montenegro, the head of Colombia’s private pension fund association, presidential frontrunner Gustavo Petro’s plans to transfer money from private pension accounts to the public system amounts to expropriation. “The money from contributions is the property of workers. A government that intends to take that money would be expropriating,” Montenegro said. Petro’s comments on pension funds are the latest in a series of policy proposals that have investors on edge, alongside plans to halt oil exploration and reform the central bank to include “productive organizations” to gain a voice in monetary policy setting.
However, it remains doubtful whether any incoming government will be able to implement radical policy shifts. Echoing Fitch Ratings’ comments of earlier in the week, Moody’s Investor Services noted yesterday that the newly elected and divided Congress would ensure that the incoming government faces checks and balances that may prevent radical reforms. Moody’s views these checks and balances as an important element of Colombia’s credit profile, as it believes any major changes to the country’s institutional framework would be cause for concern..
Chile: The next local Central Bank decision is due for release on the 29th March, risks are certainly skewed towards a more hawkish outcome given the developments in Ukraine and how this has impacted the world from an inflation perspective. Last night’s Fed announcements also tilt the scales further in favour of the hawks. Discussions of 175 bpts were on the table at the last meeting, we would not be surprised to see the bank hike by this much, with the risk that an even greater could be on the cards.
Peru: What the latest Fed announcements mean for Peru is that the BCRP will be wary of easing off from its policy tightening pedal as it will not want to fall behind the curve. On a positive note, however, the Fed's intimation that the US economy is healthy enough to withstand such an aggressive pace of policy tightening means that trade between the US and Peru should remain relatively robust. To give some context, trade between the two in 2020 came in at $12.78bn, only being exceeded by Peru's trade with China. This number certainly improved over 2021 and should keep growing for 2022 if the US economy remains as robust as the Fed expects it to
Forex: Emerging market currencies supported despite hawkish Fed
Brazil: The BRL snapped a multi-session losing streak as the combination of improved risk appetite across global markets, a weaker USD and expectations for a hawkish BCB interest rate decision provided support. The BRL was the second best performing emerging market currency on the day, gaining 1.69% against the USD to end the session at 5.0781, according to Bloomberg data. Looking at the session ahead, we expect the recovery in the BRL to persist following the hawkish BCB statement and pullback in the USD this morning.
Mexico: Wednesday was another bearish day for the MXN. It looked to revisit the 50DMA resistance at 20.5778/USD as global risk assets strengthened in the build-up to the FOMC meeting overnight. The post-Fed relief rally persisted in Asian markets this morning, due in part to hopes of progress on Russia-Ukraine talks, which bolstered risk appetite. As a result, the MXN has edged higher in pre-market trade and may continue its advance in the coming sessions if the bulls can punch through the 50DMA and 200DMA resistance at 20.4211/USD, which would also see it return to its pre-Russian-invasion level.
The MXN will likely benefit from a falling dollar and a rebound in global equities.
Heading into today’s session, the USD-MXN one-month implied volatility has extended its decline to eight successive days to 11.651%, the lowest it has been since February 28. The underlying interpretation remains one of reduced risk aversion due to responsible central banking to stave off growth, sapping inflation and the underlying strength of economies to withstand the monetary tightening.
Colombia: The COP continued to underperform its regional peers on Wednesday, depreciating 0.10% through the session while most other Andean currencies advanced. The COP tracked a further drop in oil markets, which weakened the outlook for a more positive current account. Note, however, that oil prices are on the rise today, which could provide the COP with support at the margin. The currency is establishing a new trading range north of 3800/$, although it may continue to trade with a degree of volatility as the presidential elections heat up.
Chile: The USD-CLP focused squarely to the downside yesterday with sellers evident from the get go. A spike above 809 was quickly pared and the losses continued for the remainder of the session with the closing level coming in at 799.46. Looking at today’s open there is certainly better risk on dynamics which will support the local unit at the open. Next major support level comes in at 795.92 which is the 200DMA.
Peru: The USD-PEN edged lower yesterday, tracking the improvement in risk appetite that followed on from the Fed's announcements. Traders continue to shrug off the political risks in the country, which suggests we could see a notable PEN sell-off if the debate on Castillo's impeachment does not go his way. Technically, we have a crossover buy signal on the stochastic, although it is still pointing to a general sideways trend for the pair over the near term.
Fixed Income: Curve flattening to remain a theme after the Fed
Brazil: For the fixed income market, persistently strong inflation, which has translated into a hawkish bias across central banks the world over, suggests that the broader flattening bias which has been in place for some months now is expected to persist. Mounting growth concerns underpin the noting that curve flattening will continue in the weeks and months ahead unless there is a material shift in monetary policy or global inflation pressures fall sharply. While much of the hawkishness is priced into the market, inflation risks are still skewed to the upside, suggesting that the 10v2 bond yield spread will remain inverted for some time to come.
Mexico: The IRS curve shifted lower yesterday, in line with a stronger MXN and the dip in US 10yr Treasuries and the flattening of the US yield curve as investors priced in an economic slowdown due to the more aggressive rate hike outlook signalled by the Fed. Short-term swaps rates could still be paid slightly as investors continue to assess inflation projections due to higher commodity prices and the Fed's response ahead of the expected rate hike by the central bank later this month. Banxico is expected to increase the benchmark interest rate by 50bps, which traders have fully priced in. Looking further out, the market has baked in about 160bps worth of rate hike risk for the remainder of the year, according to Bloomberg TIIE swap rates.
Colombia: The Colombian yield curve was little moved by yesterday’s Fed policy update, with the market well-positioned for an aggressive Fed tightening cycle. While the Fed’s hawkish shift yesterday almost certainly seals the deal for more rate hikes in Colombia, this has, by and large, already been priced in. Colombian bonds maintain a healthy yield spread over the US equivalents, with the 2v2yr spread currently sitting at around 664bps, while the 10v10yr spread is at 765bps. These yield premiums are high relative to historical norms, largely owing to BanRep’s 225bps worth of rate hikes since Q3 last year. Accordingly, the Colombian bond market is able to shrug off the Fed’s hawkish surprise, with the focus instead shifting back to local political developments.
Chile: The bond curve inversion pressures have eased somewhat which can be seen in the spread between the 2024 and 2032 bond. The spread is currently quoted at -161 bpts versus an all-time low of -183 bpts on the 14th March 2022. The oil price has moderated and other energy markets such as Nat Gas have pulled back from an overbought position which will ease thoughts of runaway inflation.
The risk associated with Chilean debt has also moderated, currently, the 5yr CDS is quoted at 73 bpts which is off the highs of 87 bpts on the 7th March. There is a potential for the 5yr tenor to pull back all the way to the lows seen at the start of the year of 70 bpts.
Peru: Local bonds firmed yesterday amid the improvement in risk appetite following the Fed announcements. Yields were down across the curve by up to 5.45bp, with the most pronounced moves at the front-end of the curve. This is surprising given that the more aggressive Fed policy path should lead to potentially higher rates in Peru. Local 2023 bonds are now trading at around 3.96%, suggesting that the market sees a period of rate cuts beyond the current phase of policy tightening.