Talking Points: Slowing growth justifies recent dialing back of hawkishness
Brazil: It is a busy week ahead in economic data, with many potentially market-moving economic prints scheduled for release. The start of the new week also brings with it the central bank’s latest Focus survey, which will provide updated forecasts for GDP, inflation, the Selic rate and FX. Changes to inflation and Selic rate forecasts could result in some price action in the swap market.
BRL bulls cheered the wave of positive economic data on Friday. Data released on Friday were all supportive of the BRL, with second-tier inflation data beating expectations, which helped bolster hawkish bets. On the economic front, the February industrial production and the March manufacturing PMI readings both rose notably, pointing to a recovery in economic activity. For context, industrial output rose 0.7% m/m in February from a contraction of -2.2% m/m in January. The rebound in activity was partly due to increased iron ore output from mines following a decline in January due to stronger than normal seasonal rainfall in January. The IBGE noted that there was a broad-based expansion in output, with goods production up 1.9% in February, intermediate goods output up 1.6%, consumer goods production up 0.3% and durable goods production up 0.5%.
Looking ahead, with commodity prices expected to remain elevated and covid containment measures now removed, we expect the expansion in activity in the industrial sector to persist in the months ahead. Downside risks do however exist amid ongoing supply chain pressures and increased political uncertainty ahead of the October election.
Mexico: Mexico’s manufacturing sector reported a slight improvement in March, but companies continued to suffer sales, output, and employment declines, according to the S&P Global manufacturing PMI index. The headline gauge rose to 49.2 in March from 48.0 in the month prior, remaining in contractionary territory for the twenty-fifth month running. On the price front, inputs costs rose at the second-sharpest rate since the series began in 2012 amid persistent supply bottlenecks on the heels of Russia’s war against Ukraine. Firms continued to pass additional cost burdens onto clients, with output charges increasing to their highest since August 2018. Looking ahead, optimistic projections toward output were retained, but overall confidence was dampened by inflation concerns, raw material scarcity and the war in Ukraine, the survey noted.
Meanwhile, the Finance Ministry has revised lower its economic growth forecast for the year after faster-than-expected inflation led the central bank to hike interest rates despite a stalled economy. The economy is forecasted to expand by 3.4% in 2022, compared to a previous projection of 4.1%, the Ministry wrote in a preliminary budget proposal for next year, published on Friday. For 2023, GDP is expected to grow by 3.5%. Inflation, meanwhile, is expected to slow to 5.5% by the end of the year after having reached 7.3% in February..
Colombia: The latest poll results showed that leftist Senator Gustavo Petro no longer enjoys a clear lead in the upcoming presidential elections, with the race tightening between him and conservative candidate Federico Gutierrez. Two separate surveys conducted by the National Consulting Center and Guaroma SAS (in conjunction with Ecoanalitica SAS) showed that voter intentions are technically tied in the likely scenario where the two candidates face each other in a runoff. As things stand, Petro remains the most popular individual candidate, although many centrist voters are set to back his rival in the runoff amid concerns over his more extreme and populist policy proposals
Today, the focus will be on the release of the minutes of BanRep's policy meeting last week. The minutes will provide further details on the central bank's decision to hike interest rates by a smaller-than-expected 100bps to 5.0% last week. Additionally, they may also include more forward guidance, with policymakers' reasons for not voting for a larger rate hike despite mounting price pressures, stronger-than-anticipated growth, and a narrowing output gap likely to be of particular interest
Chile: Data released from the Budget Directorate (DIPRES) has made for some welcoming reading showing that the public sector spending has begun to normalise with public spending expanding by 0.8% between January and February 2022 compared to the same period last year. This does come on the back of a massive explosion in public sector spending in 2021 when the government put measures such as the Emergency Family Income and other stimulus programmes in place to underpin the economy which had been ravaged by COVID-19 lockdowns.
The massive stimulus programmes and AFP withdrawal cash injections have supported the broader consumer driven economic growth we witnessed in 2021 which has started to slow. Data on both the manufacturing and consumer side of the equation have pointed to a slowing economy, and we received further confirmation on Friday from the Economic Activity data.
The Economic Activity data for February showed activity falling by 0.7% month on month, which was less than the Bloomberg survey of a 1% decline. The year on year print underperformed the market consensus though printing 6.8% versus a consensus forecast of 8.0%. What was however telling was the IMCE business confidence index which printed 47.50 versus 51.19 previously.
Peru: Inflation figures released on Friday showed that price pressures continued to mount in Peru in March. Consumer prices increased by 6.82% y/y and over 1.80% on a m/m basis. This was the fastest pace of price growth in 24 years, and means that inflation is above what the central bank believed would be the high point for inflation before its inflection point. Unsurprisingly, food and fuel inflation drove the headline rate higher, although other components such as shelter and recreation also registered close to the upper bound of the inflation target range. The data comes just before this week's BCRP rate announcement and almost cements the view that another 50bp rate hike is coming. It may also prompt the bank to suggest faster tightening may be coming, although there is a risk to this view given what we have seen in the likes of Colombia and Chile recently with banks hiking by less than expected.
Sticking with price dynamics, Peru has announced cuts to fuel and food taxes in order to calm protests by truckers that have taken place across the country. Consumption tax on fuel will be reduced by 90%, while a bill will be proposed to exempt taxes on basic food items like chicken and eggs. The tax cuts may help to reduce inflation in the coming months, although this may now be countered by an increase in minimum wages.
Forex: Latam currencies lead global gains for Q1
Brazil: The BRL reaffirmed itself as the standout emerging market currency on Friday as the local currency extended its winning streak. Specifically, the BRL ended the session -1.74% firmer against the USD at 4.6592, its strongest level since March 2020. The appreciation in the BRL on Friday came despite a stronger USD and lingering external headwinds as BRL bulls cheered the influx of upbeat economic data released on Friday. The BRL has now gained more than 20% against the USD since the start of the year, more than twice that of the next best-performing currency.
Mexico: The USD-MXN continued its trend lower on Friday, underperforming other emerging market FX pairs to briefly touch a nine-month low in the region of 19.7500 as higher commodity prices and interest rates lent optimism to the MXN bulls. The new week has started the way the last one ended, with further losses for the pair. Further losses could open up a path toward June’s low of 19.598, then onto 2021’s low of 19.549, last seen on Jan. 21. Some consolidation in the trade-weighted USD is likely to extend through the next few days as investors mull the inversion of the yield curve against the backdrop of the latest Fed minutes. This should offer the MXN bulls a favourable tailwind. Notably, the USD-MXN has retreated more than 3.6% this year, resulting in the MXN ranking among the top six emerging market currencies tracked by Bloomberg.
Colombia: The COP managed to recover intraday losses on Friday, closing the session and week somewhat stronger just below the 3755/$ mark. It showed resilience into the end of last week, and will need to continue doing so at the start of this week as investors position for a less aggressive rate-hike trajectory in Colombia, and softer oil prices. In this context, the COP bulls may struggle to add to the currency's March advance, with consolidation above 3750/$ the most likely outcome in the near term.
Chile: The CLP is the 4th best performing currency against the greenback year to date with the ZAR, PEN and BRL performing better. The CLP has gained 8.89% against the dollar with a number of factors converging to support the currency. First, we have the BCCH hiking rates, albeit at a less aggressive pace than originally hoped for, second the trade dynamics for the country remain positive and third, we see a benefit to LATAM and South Africa as emerging market investors rotate away from Eastern Europe given the contagion risk from the Ukraine/Russia conflict.
Peru: Despite the weakness in the bond market on Friday, the PEN rallied on the session to close the week at a new YTD high. The PEN ended Friday at 3.635 to the USD, tracking gains amongst most of its Latam peers. This cemented its position as the second-best performing EM currency for this year so far, behind only the BRL. The next level to watch will be around 3.590 to the USD, last seen in April 2021. It will be interesting to see if it can sustain these current gains. On the positive side, Peru's terms of trade has surged again to new 2-month highs, while the currency is a little undervalued on a REER basis. However, this could be offset by increasing political uncertainty, which will demand a risk discount being priced in that will offset the undervaluation.
Fixed Income: Front-end rates may continue to be received lower
Brazil: In line with the BRL, Brazilian bonds rallied on Friday as investors continued to take advantage of the attractive yields on offer. Adding to the bullish bias was easing inflation fears on the back of the appreciation in the local currency and the drop in international oil prices. Yields across the curve traded lower, with the 2yr and 10yr yields plunging 22bps and 29bps to 11.95% and 11.33%, respectively.
Mexico: The bullish bias in the local bond market came to an end on Friday as investors' focus shifted to the Federal Reserve’s monetary policy, ahead of the central bank’s latest meeting minutes due later in the week. The US Treasury yield curve is flashing more warnings after inverting again this morning, raising concerns that economic growth will slow as the Fed raises rates to tame inflation. It would not be surprising to see global bond yields rise further from here, and where they will end up is difficult to predict as markets remain volatile. Meanwhile, the MXN 2v10 bond yield spread has continued to compress, now trading at negative 8bps to indicate that the yield curve has inverted as well. Given Mexico’s already weak growth outlook and short-term expectations for interest rates to rise, we could see the inversion in the sovereign bond curve become more pronounced in the near term, but does not necessarily imply an impending recession for the domestic economy.
Colombia: Yields dropped sharply at the front end and belly of the Colombian yield curve last week, leading to a notable bull-steepening thereof as the market reacted to BanRep's smaller-than-expected rate hike and relatively less hawkish policy guidance. This was consistent with strong receiver interest in the IRS market, with the 2-year swap rate declining around 65bps on Friday to take its weekly drop to 135bps. This move also unwound the recent inversion of the IRS curve (2v5), pointing to market expectations for a more gradual BanRep rate-hike trajectory. While there have been some signs of IRS rates rising overnight, the broader bias remains to the downside. Accordingly, short-end bonds may also attract some added demand in the sessions ahead.
Chile: The economic data released on Friday underpinned thoughts of a slowing economy and thus justified further the BCCH’s most recent outlook on monetary policy, which has tempered substantially. It was thus not surprising to see receivers once again more aggressive on the front end of the swap curve and this caused further dis-inversion, 2v10 now marked at -97.50 bpts versus the highs of -204.5 bpts seen on the 18th March. The unwinding of the inversion trade has been vicious, which given the stretched nature of the inversion was not surprising.
Peru: We had a correction in the local bond market on Friday, driven by higher UST yields and surging local inflation. The curve bear flattened out with front-end yields rising by more than 20bp as traders will be bracing for a potentially more hawkish BCRP this week on account of the surge in CPI in March. Yields will also be pressured higher by news regarding the minimum wage increase and cuts to taxes, eroding some of Peru's fiscal prudence. This could generate a bit of rotation away from Peru and into some of its Latam peers, given the recent monetary policy signals that we have seen out of Brazil, Colombia, and Chile.