Morning Note /

Latam Daily: Inflation still elevated as focus shifts back to US CPI

  • Talking Points: Mexican and Chilean inflation still elevated, Peru rates to head to neutral

  • Forex: Latam FX to track USD as inflation remains in focus

  • Fixed Income: Rally for US yields keep pressure on Latam bonds

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

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

Talking Points: Mexican and Chilean inflation still elevated, Peru rates to head to neutral

Brazil: The start of the new week brings with it the central bank’s weekly economist survey which will provide investors with the latest forecasts on inflation, GDP, FX and the Selic rate. As always, the outcome of the survey has the potential to provide domestic markets with some fresh directional impetus. Recall that last week economists cut their estimates for the GDP in 2022 to 0.36% from 0.42%.

On the news front, President Bolsonaro suggested that there is a possibility that public sector workers won't receive a raise in wages for the fourth consecutive year. This comes despite pressure for public workers, which has led to cargo holdups and work slowdowns. The push from public workers for wage increases is the latest threat to the government’s books and will be a concern for fiscal hawks. An economy minister official familiar with the matter said that a 10% salary increase for public servants would cost public coffers BRL 20 bn, adding that there is no budget space for that.

Mexico: December’s inflation reading provided little relief for the new central bank governor, as it remained more than double the bank’s target, even though it slowed down a fraction from November. In December, consumer prices rose 7.36% y/y, undershooting market expectations for a pronounced increase of 7.45% y/y and just below November’s 7.37% y/y print. While the reading was less than expected, it remains near the highest in twenty years and remains a concern as core inflation rises. Annual core inflation accelerated to 5.94% y/y, its fastest pace since 2001, from 5.67% y/y in November. Accelerating core inflation suggests that price shocks are now passing through from volatile goods to usually more stable ones. A significant bump in the minimum wage will likely spur inflation in January.

The central bank has attributed the higher inflation to several external and domestic causes. They include rising energy costs as economic activity picks up from the 2020 recession; supply-chain problems that have pushed up producer costs; large stimulus spending by advanced economies; and a recovery in services after mobility restrictions were lifted and economic activities reopened. The bank also projects that it will take until the end of 2023 for inflation to return to its 3% target.

Chile: Data released on Friday showed that inflation in Chile accelerated to a 14-year high, coming in at 7.2% y/y for December. The reading beat expectations of a rise to 7.00% from 6.7%, as higher food prices offset a slight deceleration in energy inflation. Core prices, meanwhile, expanded by 5.4% y/y from 5.1% the month prior with accelerating inflation seen in categories ranging from vehicles to beverages to personal care items. Services inflation also surged to 7% y/y from 6.2% the month prior. The uptrend in non-core inflation confirms that price pressures are embedded in the economy at the moment, and that the central bank will need to continue to raise rates and tighten policy to bring it under control, even amid expectations that economic activity will slow.

Meanwhile, the trade figures were a bit more positive, showing that the trade surplus narrowed by far less than expected. The surplus narrowed to $520mn from $840mn, but this was way better than the expected drop to just $200mn. Exports came in at $9037mn compared to imports of $8517mn. This suggests that trade will have contributed positively to economic growth numbers for Q4, despite the brief drop to a trade deficit in October. Going forward, we should see imports remain elevated amid flush cash conditions locally. Exports, however, may struggle to grow from current levels over the near term as commodity prices have eased a bit and global demand has faltered a little bit due to the Omicron variant and the latest restrictions, particularly through Europe

Peru: Speaking at a press conference on Friday, BCRP Chief Economist Armas said that interest rates would move towards a neutral level in the coming months. So far, however, there have been no discussions regarding taking it above that level to where it will start to restrict economic activity. Armas also sees the current wave of COVID cases as unlikely to have a notable impact on the economy. This means that we should see business confidence levels recover, according to the economist. While this may be true to some extent, the current political situation suggests that confidence levels will likely fall short of their pre-pandemic levels once conditions normalize. The government will need to provide more certainty for a full recovery.

Health Minister Cevallos was also on the wires on Friday, stating that no mining or exploration activities are justified if they endanger human lives or harm the environment. These comments come as concerns are rising over the pollution caused by mining activities as well as the increase in heavy metals found within Peruvians. A committee has been formed to address these issues, which could add to difficulties that mining companies will face in starting new operations in the future if reforms and measures are not implemented properly. If measures are implemented effectively and support investment in a sustainable way, then it will be a step forward in creating a positive environment between miners and the communities in which the activities are based.

Forex: Latam FX to track USD as inflation remains in focus

Brazil: In line with the broader bullish bias in emerging market currencies, the BRL staged a solid recovery on Friday. Underpinning the broad-based rally in emerging market FX on Friday was a sharp correction lower in the USD following the disappointing US payrolls print, which undermined hawkish minutes from the Federal Reserve. The BRL was the fifth best performing emerging market currency tracked by Bloomberg on the day, gaining 0.91% against the USD to end the session at 5.6342, according to Bloomberg data.

A poll conducted by Reuters showed that the BRL is expected to oscillate around the 5.60 per USD mark in the weeks ahead. According to the median estimate of 21 foreign exchange strategists polled, the BRL is seen strengthening by 1.4% to 5.62 per USD by the end of Q1 as long as Brazil's fiscal problems remain under control. This comes against the backdrop of better than expected fiscal data and the most aggressive monetary policy tightening in the emerging market space.

Mexico: The MXN closed the first week of 2022 at its best level in two months, extending its weekly advance against the USD to the sixth straight week. The local currency closed the week out at 20.400/USD, a gain of 0.6% to retain its spot in the top ten performing emerging market currencies. Though the MXN was able to defy soaring US Treasury yields, its potential to continue its upward trending is limited. The 200DMA, currently at 20.274/USD, acts as an MXN barrier in the near term. Additionally, the cautious undertone across financial markets in the build-up to this week’s US CPI reading will keep the MXN bulls in check. Heading into the new week and the NorAm session, the MXN is on the back foot and will be looking to the local data card for impetus.

Chile: It turned out to be a stellar start to the new year for the CLP, with local currency recording the second-best performance against the USD amongst the 24 emerging market currencies tracked by Bloomberg last week. Specifically, the CLP ended the week 2.82% stronger against the greenback at 828.65, according to Bloomberg data. This marked the CLP’s strongest level in over a month. Friday also marked the first time since mid-November that the CLP has managed to sustain a break below the 50-day moving average after the local currency gained more than 1.00% against the USD on the session. The strong rally in the CLP came against the backdrop of a pullback in the USD, higher than expected inflation and robust copper exports data with the value of Chile’s copper exports up by more than 40% in 2021.

Peru: A hawkish local central bank and a weaker USD helped the USD-PEN pair break below the 200DMA support on Friday. The pair closed the week at 3.935, its lowest level since the mid-October bottom. For how long it can remain near current levels is still questionable, given the local political concerns and rising expectations for higher interest rates and monetary tightening in the US. Current levels look very attractive to the USD bulls and we should see any further dips scooped up very quickly.

Fixed Income: Rally for US yields keep pressure on Latam bonds

Brazil: While the US jobs print disappointed on Friday, the 10-year UST yield has continued to rise towards 1.80% this morning, following on last week’s surge from levels close to 1.50%. Multi-decadal high inflation in the US, with the prospect of more to come, has driven the benchmark tenor’s yield to levels last seen in January 2020, i.e. pandemic-era highs.

The surge in the 10-year UST yield to a pandemic-era high bodes ill for the outlook of equities and other relatively higher-risk assets. However, to be sustained, it may require US inflation data to continue coming in very hot, and the Fed to remain extremely hawkish in its forward guidance.

Notwithstanding the marked appreciation in the BRL, Brazilian bonds ended the week on the back foot, with yields across the curve trading higher. For context, the shorter-dated 2yr yield rose by 6bps to 11.77%, while the longer-dated 10yr yield climbed 10bps to 11.45%. The bearish bias in Brazilian bonds was driven by a combination of renewed fiscal concerns and expectations for more aggressive policy tightening in the US, with some economists now pencilling in as much as four interest rate hikes in the US this year..

Mexico: Following Friday’s inflation report, MXN bond yields rose slightly on the front-end of the curve but were outperformed by tenors on the long-end. Specifically, the 20yr bond yield fell by almost 4bps, leading the way lower. Investors are likely still assessing the inflation figures and the central bank's policy response to bring inflation back in line with its target rate. This was represented in the swaps market, with the swap rates paid only slightly higher on the front-end of the IRS curve, but not enough to drive a bear flattening bias in the curve.

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: Sovereign yields ended the week higher, keeping the streak going as the pressure on global bond markets persisted amid inflation and Fed tightening concerns. There was also some reaction to the more hawkish BCRP, which drove front-end yields to highs not seen since mid-2019. The 2023 tenor, as a result, is nearing the 4.000% mark and we could see that level reached in the coming weeks if the Fed remains as hawkish as it is currently, and local inflation numbers remain elevated.