Morning Note /

Latam Daily: Leaders look to ease fears over Andes fiscal risks

  • Talking Points: Boric looks to soothe investor concerns, Brazil’s services sector performs well

  • Forex: US data releases to drive FX direction into the weekend

  • Fixed Income: Peru bond rally appears to have topped out

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Daron Hendricks
Danny Greeff
Kieran Siney
ETM Analytics
14 January 2022
Published by

Talking Points: Boric looks to soothe investor concerns, Brazil’s services sector performs well

Brazil: The services sector smashed the lights out in November. Data published by the IBGE on Thursday revealed that activity in the services sector grew by 2.4% y/y in November, much higher than the consensus expectation for an increase of 0.2%. On an annual basis, services activity expanded by 10.0% in November, up from 7.5% in October. A breakdown of the report revealed that 4 of the 5 sub-sectors were up from the previous month, led by a 5.4% increase in information and communication services. The November services report is encouraging, given that the services sector accounts for around 70% of Brazil’s economy. Underpinning the strong performance in November was a combination of the reopening of the economy and an acceleration in the vaccine program. The robust November services print helped quell fears over Brazil’s deteriorating economic outlook.

The session ahead will see the release of the November retail sales report. It is widely expected that the retail print will make for some sobering reading after yesterday’s stronger than expected services report. Consensus expectations suggest that activity in the retail sector was unchanged from the previous month in November. On an annual basis, activity is seen contracting by -5.6% in November. Weighing on the retail sector is the shift from goods to services as the economy is reopened and higher interest rates that have decreased the purchasing power of consumers.

Mexico: Mexico is under pressure to speed up its vaccine campaign as the Omicron variant fuels a surge in daily coronavirus cases. Based on the latest update by the Health Ministry, Mexico registered a daily rise of 43,523 new covid-19 cases yesterday, bringing total infections to 4,26mn. Additionally, hospital bed occupancy has risen to 26%. The nation is expecting a delivery of nearly 27mn additional COVID-19 vaccine doses in the coming weeks, which will help curb the virus's impact on hospitalisation.

In an ongoing dispute with the US over its interpretation of how free trade rules apply to the auto industry, Mexico is now being joined by Canada. The move is an escalation of the issue, which Canada previously said it was monitoring. The conflict concerns differences over the percentage of a vehicle that comes collectively from the three countries needed to trade duty-free. Both Mexico and Canada believe the trade deal stipulates that more regionally produced parts should count toward duty-free shipping than the US wants to allow. Under the revised USMCA trade deal, 75% of a vehicle’s components must originate in North America to qualify for tax-free status, up from 62.5% under the old NAFTA agreement. This will be a key development to watch in the coming months, given the importance of the sector for the region and ensuring healthy trade-ties between the respective nations.

Colombia: Colombian President Ivan Duque and Peruvian counterpart Pedro Castillo signed a presidential declaration, including bilateral agreements, following the presidential meeting and 6th binational cabinet held in Villa de Leyva. Duque said that the two countries engaged in fluid and coordinated dialogue, which reaffirmed the strong and binding ties between the two nations and a great common agenda of fighting poverty. "We hope to make even more progress during that meeting and continue to draw up a work plan in many sectors so that binational trade, which has exceeded $2bn, can grow," Duque said, as he expressed his support for multilateralism

Heading into the weekend, there is very little in the way of market-moving data out of Colombia to digest, with only the central bank's economist survey on expected interest rates, inflation, and FX scheduled for release. Domestic COVID-19 dynamics may draw some focus, however, with the daily spread rate in Colombia remaining high at recent peaks after the festive holiday period. This holds limited market-moving potential, though, as Colombia's government has signalled readiness to put the pandemic behind them and focus on economic development.

Chile: President-elect Boric was on the wires yesterday, stating that he views the current consumer spending boom as unsustainable and that the country's finances are under pressure. To address this, Boric has said that he will make changes in a gradual way to prolong the economic expansion and put it on a more sustainable path. To do this, Boric said he would look to boost investment while protecting the environment, and provide tax reforms that will generate greater revenues while providing investors with legal guarantees. Boric has definitely toned down his rhetoric since winning the elections, and the recent comments will be seen as positive for investors. The question now is whether or not he sticks to this and provides the right balance between encouraging investment and meeting some of his more social-oriented election pledges.

Boric sees the country's budget deficit as being reduced from 2023 onwards, and he pledged to keep it at the target of 4% going beyond that. There were also the usual pledges of supporting the renewable energy sector of the economy and addressing wealth distribution. Finally, Boric noted that he has not made a decision regarding the awarding of the two lithium contracts under the current administration, stating that important decisions such as that must not be made at the last minute

Peru: It is another quiet session ahead in terms of local economic data, although there will be two key releases out over the weekend. The November economic activity index will provide an update into the health of the economy just before the global Omicron scare. The figures are expected to show that growth was slowing in Q4 compared to Q3, although overall activity levels will remain above pre-pandemic levels, but still below potential. Unless we see any major surprises, the figures shouldn't be too market-moving or alter the outlook for the BCRP and its rate hike path.

The central bank announced yesterday via Twitter that that fiscal deficit narrowed to 2.6% of GDP in 2021 from 8.9% in 2020. This was helped by a 41% increase in VAT collection for the year and a 43.8% increase in income taxes as the economy reopened. The central bank also mentioned that total jobs in the formal sector are now above pre-pandemic levels. This comes ahead of the jobs data out tomorrow, which could show a further reduction in the unemployment rate. There are, however, still a greater number of unemployed in the informal sector, which will keep the overall rate higher than what was seen before the COVID outbreak.

Forex: US data releases to drive FX direction into the weekend

Brazil: After testing a key level of support, the 100-day moving average (5.4993), the USD-BRL failed to sustain the downside move, closing the session 0.16% higher at 5.5289, according to Bloomberg data. While the BRL snapped its winning streak yesterday, the broader bias in the BRL this year remains moderately bullish, with the currency being supported by improving monetary policy dynamics, a weaker USD and an improvement in global risk sentiment. Despite coming under stern selling pressure in the first 3 sessions of the year, the BRL has appreciated by 0.84% against the greenback on a year-to-date basis.

Mexico: The USD-MXN slipped 0.1% yesterday to 20.3569 as the key short-term barrier for the MXN bulls, the 200DMA at 20.2780 held firm. A clear break below the support could clear the way to more losses for the USD-MXN, with it targeting the 20.1500 mark and potentially the 20.000-handle. Though the USD-MXN’s bear rally is becoming stretched, it may have the legs for another run lower. For now, the USD is unwinding its overvalued position, with one eye on the data today to guide the bias through the week ahead. This is providing the USD-MXN with a positive tailwind this morning as it pressures the 200DMA to extend its bearish bias.

Meanwhile, the one-month USD-MXN implied volatility is hovering around the 9.449% mark this morning after extending a decline for seven successive sessions to an Oct. 29 low.

Colombia: The COP added another 0.15% gain to this week's rally, as it continued to capitalize on the USD's recent correction. A relatively uneventful week on the local front means the spotlight has been on external developments and oil-market dynamics, all of which have generally been COP-supportive. It must be noted, however, that the COP bulls appear to be running out of steam, with the market rejecting stronger levels during yesterday's session. Investors may thus increasingly look to book profits on the COP's recent rally, although much depends on how much longer the USD's pain trade will persist.

Chile: The CLP extended its winning streak on Thursday as the dollar continued to slide. Specifically, the CLP ended the session 0.71% firmer against the USD at 817.70 even though the rally in commodities dwindled. Technically, the USD-CLP tested a break below the 100-day moving average, which sits at 815.91 but was unable to hold onto these levels. Looking at the session ahead, the local agenda remains thin today, and as such, the CLP is likely to take direction from the broader macroeconomic themes at play and developments in the external market.

Peru: The USD-PEN gapped higher at the open yesterday but then dipped to end the session basically flat just below the 3.9000 level. The PEN was outperformed by the COP and CLP on the day as a result, with a similar pattern seen when looking at the YTD performance. The PEN is usually the least volatile of these currencies and we could see its volatility levels start to subside further in the absence of any local political events.

Fixed Income: Peru bond rally appears to have topped out

Brazil: It was a mixed session for Brazilian bonds on Thursday. Yields on the front end of the curve were little changed with the 2yr, for instance, closing the session at 11.70%. The downside bias from Wednesday’s session on the long-end of the curve meanwhile persisted yesterday, with the benchmark 10yr yield shedding 8bps to close the day at 11.31%. This saw the 10v2 spread reverse much of its topside move made in the previous session.

On the fiscal front, Brazil’s 5yr USD credit default swap, which we use as a proxy for fiscal risk, has traded higher this year, reflecting the deterioration in hard currency lending conditions as the Fed continues to taper, renewed fiscal and political concerns and persistent weakness in the BRL. For context, Brazil’s 5yr CDS climbed to 218bps on Thursday. Note that while Brazil’s CDS is the third highest amongst the 24 emerging market countries tracked by Bloomberg, at 218bps, the market is pricing in a low risk of the country slipping into a position of fiscal distress in the medium term.

Mexico: Mexican bonds have gained in back-to-back sessions, with yields falling by 4 – 6bps, in line with the retreat in US Treasury yields. While Mexico’s borrowing costs have come down so far this week, with yields on the belly and long-end of the curve down 25bps – 30bps, it may be unwound shortly amid the growing rate hike drumbeat by the US Federal Reserve. As a result, the US 10yr Treasury yield has spiked this morning to 1.736%, generating a fresh bout of risk-off. Much of the local bond market's performance heading into the weekend will hinge on external factors.

Colombia: Colombian bond yields dropped for a second consecutive day, suggesting an easing of pressures the market has faced in recent weeks. Nevertheless, yields will still end the week higher than they started, meaning it is still too early to call this recent consolidation the beginning of a reversal. Investors remain extremely cautious over political uncertainty ahead of the upcoming congressional and presidential elections later this year, with the recent recovery more likely a function of the COP's recent recovery on the back of a retreating USD. More of the same is expected into the weekend, with very little in the way of market-moving data or news flow for investors to digest locally.

Chile: It was another day with the bears at the helm, with yields across the Chilean bond curve trading higher on Thursday. The topside bias in bond yields came despite the warnings from President-elect Gabriel Boric that the economy was running too hot and that his government would support fiscal stability. As noted above, Boric said in a statement released yesterday that the boom in consumer spending was unsustainable, adding that public finances were under strain. Movements across the curve were notable, reflecting a broader bearish bias towards Chilean sovereign debt.

While fiscal risks in Chile remain elevated, it is worth noting that the strong flattening bias remains entrenched as soaring inflation expectations continue to pressure shorter-dated bond yields. As mentioned in recent commentary, given that inflation risks remain skewed firmly to the topside, we expect the flattening pressure to persist in the months ahead, especially now that fiscal and political uncertainty has calmed with the presidential election out of the way.

Peru: It was a quiet session for the local bond market yesterday, with the curve holding flat through the day as the rally spurred on by the sliding USD seems to be coming to an end. Despite the market reaction to the Fed and US CPI, it is still expected that there will be several rate hikes in the US this year which will continue to have an impact on emerging market debt. After the recent rally for local bonds, therefore, there is the possibility that we could see some profit-taking, especially if we get any negative shocks on the local front.