Morning Note /

Latam Daily: Inflation still in focus but politics rearing its head again

  • Talking Points: A busy day on the data front, Peru’s Congress votes on impeachment

  • Forex: Rebounding risk assets bode well for Latam FX today

  • Fixed Income: Brazil to offer linkers, Chile’s CDS spreads narrow

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Daron Hendricks
Danny Greeff
Kieran Siney
ETM Analytics
7 December 2021
Published byETM Analytics

Talking Points: A busy day on the data front, Peru’s Congress votes on impeachment

Brazil: Brazil’s economic calendar is relatively sparse today. The only notable release is the November FGV inflation report. While it is a second-tier inflation reading, a surprise in the reading has the potential to provide some fresh impetus for domestic markets, given the sensitivity of local markets to inflation and monetary policy dynamics at the moment. Consensus expectations suggest that monthly inflation as measured by the IGP-DI index likely fell by 0.51% in November. On an annual basis, the IGP-DI index is seen rising 17.23%.

In a further indication that inflation risks remain acute, economists polled in the central bank’s weekly focus survey upwardly revised their inflation forecast and now see inflation breaching the upper limit of the central bank’s inflation target next year. Economists now expect headline inflation to reach 5.02% at the end of next year. Economists lowered their 2022 growth forecast to 0.51% from 0.58% previously. The revisions to the 2022 growth forecast come even though the Senate last week approved a bill that will loosen the country’s spending cap rule to make room for increased cash handouts to around 17mn of the country’s poor.

Mexico: Mexico’s energy overhaul stalled on the lack of support from opposition parties. The vote, which lawmakers initially hoped to have wrapped up this year, will take place in 2022, providing an opportunity to receive the two-thirds majority needed for approval, according to comments made by Juan Ramiro Robledo, chairman of the Points Commission.

The day ahead is filled with some key economic data releases. One, in particular, will be Mexico’s gross fixed investment (GFI) figures for September. On a y/y basis, GFI activity is likely to continue its downward trend as base effects continue to unwind. Meanwhile, August’s m/m figures reported a slowdown in growth (1.13% from 2.48% in July). Given that October saw an overall increase in economic activity, in line with fewer infections and lockdowns, we see a slight increase in GFI. If not, it would be the second monthly decline and slip below its pre-pandemic levels.

Colombia: According to an Invamer poll published by Blu radio, leftist Senator Gustavo Pedro would have more than double the support of his closest rival if elections were to take place now. Colombia's elections are only scheduled for May next year so plenty can change between now and then, but Pedro appears to have a resounding lead at this time. It is likely still too early for the market to react to these political polls; however, should Pedro maintain his lead closer to the elections, some market concerns may arise over Colombia's economic and fiscal prospects going forward.

Chile: It is a busy data day on the local front with the likes of inflation and trade numbers on the cards. The inflation reading is expected to come in at 6.6% year on year versus 6.0% in Sept. The major drivers of the rise in inflation is likely to be the accumulated currency depreciation coupled with higher commodity prices and strained supply chains, added to this we have yet to see a massive tempering of domestic demand, all of this coupled with base effects will underpin todays reading.

Next up, the trade numbers. Market expectation is for the trade balance to move back into surplus which will assist the currency in regaining some of its resilience. The market is looking for a surplus of a quarter of a billion dollars against a deficit of $352m in October. Higher exports will be the primary driver with preliminary figures showing higher shipments of manufactured goods. Reserves also headline today and a build here will help build fiscal and currency resilience at a time when its sorely needed

Peru: It could be a big day for Peru today as Congress will decide whether or not to impeach President Castillo. Today's debate will see the motion passed if 52 lawmakers back it. If so, it will then head to another vote where Castillo will need to defend himself to lawmakers, but could be ousted if two-thirds, or 87 members, opt to remove him. At the last count, around 50 lawmakers currently support impeaching Castillo, meaning that the first round of votes will be very close. It is still open whether or not the final vote will see the 87 or more votes needed, but the risk is there and cannot be ignored at the moment.

Although Castillo and Peru Libre Party leader Cerron have had a falling out, Cerron tweeted over the weekend that his party will back Castillo. The party has 37 seats in Congress, not enough to prevent the impeachment outright but enough to make the outlook quite uncertain. Weighing against Castillo at the moment are his poll numbers. A recent poll suggested that Castillo has an approval rating of just 25%, down 10 percentage points from a month ago. What could be Castillo's saving grace is how early it is in his term. Impeachment obviously creates a lot of political instability that not all lawmakers want so soon after the elections.

Forex: Rebounding risk assets bode well for Latam FX today

Brazil: While the BRL extended its losses yesterday, depreciating by -0.59% against the USD to end the session at 5.6860, the BRL has regained the attention of fund managers as investors look to take advantage of the significant undervaluation in the local currency as the underlying macroeconomic picture continues to improve. One of the main factors that should support the BRL in the months ahead is the aggressive pace at which the central bank is hiking interest rates. The benchmark Selic rate is widely expected to reach double-digit territory in the first few months of next year as policymakers rein in inflation.

The sharp increase in interest rates and marked undervaluation in the BRL has significantly increased the local currency’s carry appeal. According to ETM’s carry attractiveness model, the BRL has the highest carry appeal of the 22 currencies included in the model. Note that the BRL has lost almost a third of its value since the Bolsonaro administration took office.

Notwithstanding the volatility in the BRL, investors favour betting on the BRL against other emerging market currencies, given how cheap the local currency is on a valuation basis. That said, hedge fund managers remain cautious of turning overly bullish on the BRL, given all the uncertainty linked to the 2022 presidential election..

Mexico: The USD-MXN drifted lower on Monday, weighed down by elevated commodity prices and subsiding fears over the omicron coronavirus variant. Still, the pair lacked the impetus for a sustained break below the 21.2000 support and instead closed at 21.2247. The bias for the USD-MXN remains bearish, and will continue to see the pair eye the 21.00-handle. Much of this move lower will depend on the USD. Currently, the greenback is reluctant to rally much further, while the weekly chart shows the USD to be overbought, and fundamentally, there are good reasons to argue for a USD correction. This could see investors shift back out of safe-haven assets and see riskier assets stage a recovery in the year's final weeks.

Colombia: The COP was among the best performers in the EM currency basket on Monday, recording a 0.90% appreciation against the USD. The market was positioning for a more aggressive BanRep tightening trajectory after this weekend's higher-than-expected CPI numbers, which, coupled with recovering oil prices and easing COVID-19 fears, drove improved demand for the currency at the start of the week. The latter two themes will likely remain in play today, meaning the COP could continue its early-week recovery.

Chile: It’s hard to buck the trend when it comes to the USD-CLP. Yesterday we fell just short of the annual high of 849.25 before closing at 846.53. We remain buyers on any dips with 820 being the first major support level followed by 813.78 which is the 50DMA.

Peru: The USD-PEN climbed to 4.0855 yesterday, tracking the likes of the USD-CLP higher in what was another session characterized by low liquidity levels, while the central bank continued with its FX interventions. The grind higher for the pair is bringing the 4.1000 handle back into view, but we could see it take a breather today as traders will be waiting to see what happens with the vote in Congress, which will likely only come after market hours today at the earliest.

Fixed Income: Brazil to offer linkers, Chile’s CDS spreads narrow

Brazil: The recovery in Brazilian bonds came to a halt on Monday as inflation expectations intensified after oil prices rebounded strongly and the BRL extended its losses. For context, the front-month Brent contract rose back above $73 per barrel after touching lows of nearly $65 per barrel at the worst of its decline. This comes as the market is tempering its concerns over the economic impact of the Omicron variant of COVID-19, as rising infection rates have not led to increased hospitalisations. Despite this, travel restrictions are still in place in many countries, which will crimp fuel demand as we head into a busy travel season as the holidays approach. This suggests that we should see the rebound persist but that it will be fairly gradual and subject to some volatility.

Yields across the bond curve ended the session marginally higher after falling sharply last week. Looking at the shape of the curve, it is worth noting that the curve remains inverted when looking at the 10v2 yield spread. That said, the degree of inversion has decreased notably with the 10v2 spread sitting at -9bps at the end of yesterday’s session compared to a low of -61bps at the start of November.

Going forward, we expect the curve to remain marginally inverted or at least very flat in the near term as heightened inflation risks continue to buoy yields on the front end of the curve. While inflation risks remain elevated, the BCB is expected to stick to its forward guidance and deliver a 150bps rate hike tomorrow evening. Traders are pricing in an implied probability of 81% for a 150bps rate hike.

In the primary market, National Treasury plans to sell inflation-linked NTN-B bonds maturing in 2024, 2028 and 2040 at its weekly auction today. While inflation risks have moderated, they remain acute. As such, we expect demand for inflation protection through inflation-linked bonds to remain healthy.

Mexico: Mexican bonds consolidated yesterday following two weeks of gains. The swaps markets saw slightly more trading action, with a receiver’s bias taking hold on the front-end of the curve, but not considerably enough to alter the shape of the IRS curve.

In an interview yesterday, Mexico’s Deputy Finance Minister, Gabriel Yorio, stated that Pemex would sell between $700mn and $1bn in dollar-denominated bonds. The issuance will be part of the government's bailout plan to shore up its finances. According to Yorio, this is estimated to reduce Pemex’s net debt by $3.5bn. While the outstanding debt pile remains large, some consolidation will alleviate downward credit rating risk on the nation’s sovereign bonds rating..

Colombia: The Colombian yield curve bear-flattened notably at the start of the new week, as investors drove up short-end yields in response to the higher-than-expected CPI print on Saturday. The 2-year bond added around 13bps to its yield through the session, while the 4-year to 6-year section of the curve increased around 6bps-12bps. This reignited the market's recent flattening bias, with Colombia's inflation and interest-rate outlook likely to keep the short-end buoyed, while the long-end could be pushed lower amid growing optimism that the Omicron COVID-19 variant may not be as dangerous as initially feared.

Chile: The 5yr CDS has dropped below the 90 bpt mark following the news that the 4th Pension Fund Bill has been placed on the backburner and is unlikely to rear its head any time soon again. This places Chile in a better long term fiscal position as the assessed long term pension fund liabilities will not increase, at least for now. We are still sharply higher than the annual average which comes in at 64.8 bpts which does reflect the broader uncertainty and change in fiscal position of the country over the past four months when we saw the premium demanded to insure against default ramping up sharply.

Peru: The start of the week was a fairly quiet one in terms of movements across the local bond curve. We saw some pressure on tenors at the belly of the curve, while longer-dated bonds held steady on the day. This consolidation is likely to persist through the session ahead, with investors waiting to see what happens with the vote in Congress. As we noted yesterday, it is difficult to see the country's fiscal fundamentals improving enough over the longer term to drive any significant rotation back into local bonds through 2022. Spending levels will remain high and they will not be accompanied by the needed increase in productivity to help mitigate the increased fiscal risks. This increase in spending also leaves room for higher inflation levels to persist, which will keep borrowing costs elevated even if it helps reduce some of the debt burden in real terms by way of increased nominal tax intake.