Talking Points: S&P downgrades regional growth outlook for 2022
Brazil: It is a busy day ahead in terms of economic data. Fiscal and labour market dynamics will be the focal point today. Consensus expectations suggest that Brazil recorded a primary budget surplus of BRL 35bn in October, up from a surplus of BRL 12.9bn in September. Given the sensitivity of financial markets to inflation dynamics at the moment, investors will also pay close attention to the October jobs report. It is expected that Brazil’s economy added 265k jobs in October compared to 314k jobs in the previous month.
Global ratings agency S&P lowered its 2022 GDP growth average for six major Latin American economies to 2.0% from 6.6% expected in 2021 on Monday. The ratings agency said that the downward revision was mainly due to monetary tightening, removal of fiscal stimulus and low levels of policy predictability. S&P said that the Omicron variant of COVID-19 increases downside risk to its baseline GDP scenario, especially if widespread mobility restrictions are implemented. The agency noted that Chile and Brazil stand out for having a higher risk of GDP deteriorating more than expected next year. S&P said that in Brazil the ongoing tightening in monetary policy that is likely to continue in 2022, partly due to weaker fiscal dynamics, threatens to take a large toll on domestic demand.
On the political front, the focus remains centred on the precatorios bill. In a statement on Monday, National Treasury Secretary Paulo Valle said that the government is confident that Senate will approve the court-ordered payments bill, known as precatorios. Valle added that Brazil’s fiscal trajectory would become clearer and benefits would be brought to the macroeconomic policy after the bill is approved. Recall that the bill will free up the required funds for President Bolsonaro’s new social program, which he is pushing to get passed into law to boost his support ahead of the general election next year. Senate president Rodrigo Pacheco said that the court-ordered payments bill might go to vote on the Senate floor on Thursday after it is approved by the Constitution and Justice Committees tomorrow. The bill will loosen the public spending rule to make room for larger cash handouts to the poor.
Mexico: Mexico’s unemployment rate continued to fall in October, standing at 3.95% - its lowest reading since March this year. This compares with a reading of 4.18% in the month prior. The latest figure marks the third successive month of declining unemployment and outperformed market expectations for a less pronounced drop to 4.07%. Several industries that were hit hard by the pandemic continued to post substantial recoveries. According to the National Statistics Agency (INEGI), most of the recovery in jobs was concentrated in the tertiary sector. Leisure and hospitality-related sectors have continued to recover but with a lag compared to other industries due to the impact of the economic restrictions. As the economy continues to expand, we should see the labour market tighten. This narrative, of course, will largely depend on the effect the current wave of infections has on the economy and whether there is a need for tightening restrictions.
The local economic calendar heats up today. Investors will be eyeing the budget balance data amongst the other releases scheduled. Mexico’s public finances have been under strain this year, with the year-to-date budget deficit falling to MXN362.0bn at the end of September. The lack of a broader economic recovery across sectors and the government's ongoing support for state-owned companies has prevented any improvement in its monthly budget balance. This suggests that the year-to-date deficit likely continued to widen in October. Looking ahead, the weakness in the MXN will not aid the nation in paying its monthly interest repayments of pandemic related support
Colombia: The Colombian data card also heats up today with the release of October labour market statistics. Expectations are for Colombia's unemployment rate to keep declining into the end of the year, barring the re-emergence of an economically-devastating wave of COVID-19 infections. This decline would largely be a function of recovering activity due to the country's economic reopening earlier in the year, while seasonal factors may also come into play. The central bank will be watching the labour market data closely for insights into prospective demand-side inflation dynamics, meaning today's numbers may hold some market-moving potential at the margin.
Chile: Local news flow continues to surround the positioning of the political race between Kast and Boric and what each brings to the fiscal party. Financial markets remain fearful of a Boric win as he will likely push for a more socialist and interventionist stance from his government. The reality is that despite what politicians say, the economic realities often dictate the path that they follow. We expect that even if Boric does win, he will not have the fiscal room to implement everything he wishes.
Peru: President Castillo was on the wires yesterday, addressing the possible impeachment motion against him. Castillo, of course, said that this is due to political interests and is against the will of the public who voted him in. The president also had to deny allegations against him that he held meetings over the weekend with several politicians and businesspeople outside of government offices, which is illegal in the country. Whether the allegations are true or not, they have given his opposition more fuel to push for his ouster. As we have noted before, the motion has enough votes to be debated in Congress, but it is uncertain whether there are enough for it to go all the way and lead to him being impeached.
It remains a quiet session ahead in terms of local economic data, with the data card picking up tomorrow with the release of the latest CPI numbers. Expectations are that inflation continued to accelerate in November, moving further away from the central bank’s target. Both non-core and core inflation are likely to have risen, with food and fuel prices driving up the former, while the latter will remain elevated due to currency depreciation, higher external prices, as well as recovering domestic demand. Given the central bank’s current outlook, as explained below, the figures could spur on additional tightening if we see them beat expectations and continue to do so over the next few months..
Forex: Risk-off suggests currencies will remain on the back foot
Brazil: It was a fairly downbeat start to the week for the BRL. Although the BRL kicked off the session on the front foot, the bullish bias was short-lived, with the BRL reversing its earlier gains to end the day 0.09% weaker at 5.6081 as the combination of a stronger dollar and renewed fiscal concerns weighed. This came after a report suggested that the government is still considering the use of an emergency budget for the payments of the new social program. Going forward, while the USD is trading weaker this morning, which should provide some reprieve for the BRL, heightened fiscal risks will limit any gains in the local unit.
Mexico: The MXN rebounded strongly from a one-year low of 22.1550/USD to close out yesterday at 21.6771/USD, ending its recent rout over which it lost almost 6% in seven sessions. The risk-averse trading environment subsided slightly as investors assess the severity of the Omicron coronavirus strain on the world economy. There is a cautious undertone in financial markets on the final trading day of November, which is likely to see the MXN end the month on the back foot in what has been a less than favourable month for the local currency.
Colombia: The COP's bear-run extended into the start of the new week, with the currency depreciating 0.50% on Monday to close at its weakest since the onset of the COVID-19 pandemic last year. The bears are in full control at the moment, with renewed COVID-19 fears adding to existing concerns over global monetary tightening. However, the COP may turn increasingly attractive from current levels, with so much in the way of bad news already priced into the COP at present.
Chile: In terms of the USD-CLP it is hard to buck the trend with investors preferring to pay the offer as political risks and a current account deficit which is more pronounced than its peers rendering the peso vulnerable.
Peru: The USD-PEN continued to climb yesterday, rising to over 4.0600 by the close of the session as market conditions remained fairly volatile and after some technical breaks seen on Monday. The technical picture for the pair remains bullish at the moment, given that we are trading above the 50DMA and 100DMA, while the stochastics are still favouring a bullish bias even though they have now reached the overbought region. Some further gains, therefore, could be expected over the coming sessions, especially given current risk conditions.
Fixed Income: Brazil to sell linkers as inflation concerns keep building
Brazil: While international oil prices have fallen sharply in recent days, demand for inflation protection in the fixed income market remains robust. Bond traders continue to fear that Brazil could be heading towards a position of stagflation and continue to pile into inflation-linked bonds to protect their portfolios. On the back of the robust demand for inflation projection, breakeven rates on NTN-B bonds have surged in recent months and are buoyed near multi-year highs. For context, Brazil’s 2yr breakeven rate has risen by more than 300bps since the start of the year to sit at 6.77%.
Adding to inflation fears is the fact that the growth outlook has deteriorated significantly, bolstering bets that the central bank may not hike rates as aggressively as previously expected, which would translate into higher risks of inflation over the medium term. Persistent weakness in the local currency, ongoing supply chain issues and elevated food costs continue to de-anchor inflation expectations. Moreover, it is worth noting that the market is pricing in significant rate hike risk over the next 12 months, which is expected to curb economic growth further, while not necessarily reining in inflation enough given that much of the inflationary pressure at the moment is supply-side driven. Given this backdrop, we expect inflation-linked bonds to outperform vanilla bonds in the months ahead.
The session ahead will see National Treasury sell inflation-linked NTN-B bonds maturing in 2026, 2030 and 2055. As mentioned above, demand for inflation expectations is expected to remain robust. Therefore, we expect demand at the linker auction to be strong..
Mexico: Mexican bonds continued to strengthen yesterday, undoing some of their recent losses. Yields fell by 3bps – 7bps, led lower by the 4yr tenor, which has slipped from a 14-month high of 7.3295%. Investors’ panic over the Omicron coronavirus variant subsided somewhat as they looked to assess its impact on global economies. Given that the efficacy of existing vaccines against the new strain will take time to test, it leaves investors in a period of uncertainty. It appears that virus concerns are the centre of attention again today. The benchmark US 10yr bond yield has continued its slide this morning ahead of the US Open, as investors seek out safe-haven assets. As such, we could see Mexican bonds come under renewed pressure in the session ahead..
Colombia: The Colombian bond market started the new week off on the front foot, with yields generally falling by around 1bp-3bps yesterday as risk appetite recovered through the session. This occurred as Omicron fears receded amid the development of a counternarrative on the variant that allowed for some tentative optimism. However, since then, market cautiousness has returned overnight, meaning yesterday's gains could potentially be reversed today.
Chile: After bottoming out at 400 bpts the spread that the local 10yr bond is trading above the corresponding US 10 benchmark has started climbing once again. Currently we have the spread at 425 bpts as we head into the local open with the trend remaining topside focused. The major reason for the widening out has been a flight to safety of late with the US 10yr yield trending lower at a faster pace than the local bond, which has seen a fair amount of interest to receive after yields touched extremes of 6.68% on the 13th October 2021. Local bonds are still experiencing idiosyncratic pressures in the form of potentially a left leaning government coming to power and as always, the threat of the pension pot being raided again. This will keep them underperforming on a relative basis.
Peru: The local yield curve was subjected to some steepening pressures yesterday, with front-end yields and those at the belly sliding as concerns over the new COVID variant continue to impact market pricing for monetary policy tightening across the globe. There was some pressure on longer-dated tenors, however, given the current political situation in the country which is preventing investors from taking on too much duration risk at the moment. How much further yields at the front end can fall remains the question, however, given the inflation pressures building within the local economy. This will be highlighted in tomorrow’s CPI release, where the risks are skewed to the topside which will keep a floor in place for yields at the front-end of the curve.