Morning Note /

Latam Daily: Monetary policy in focus as FOMC meeting looms

  • Brazil and Colombia to release MPC minutes

  • Chilean economy remains hot

  • Odds of Peruvian Cabinet approval get a boost from minister’s resignation

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Daron Hendricks
Danny Greeff
Kieran Siney
ETM Analytics
3 November 2021
Published byETM Analytics

Talking Points: MPC minutes to suggest more rate hikes coming in the region

Brazil: Monetary policy remains the focal point today with the BCB scheduled to release the minutes from last week’s Copom meeting where policymakers delivered a 150bps hike, taking the benchmark Selic rate to 7.75%. Recall that the central bank pledged to deliver another rate hike of the same magnitude at its December meeting. The Copom meeting minutes should provide additional clarity on the path for monetary policy going forward. Traders will also be looking for insight on the potential risks stemming from the proposed changes to the spending cap rule. Note that the proposal is likely to get its first floor vote today.

While the BCB scaled up the pace at which it is tightening monetary policy by delivering a 150bps last week, the market assessed the rhetoric used in the policy statement to be far less hawkish than what it deems necessary to bring inflation under control. The reaction across Brazilian markets suggests that traders were looking for an even bolder move from the central bank following the recent escalation in inflation pressures. This led to a marked slide in the currency and a significant steeping in the yield curve in the days that followed the meeting.

Today will also see the release of Brazil’s October trade numbers. Expectations are that Brazil’s trade balance narrowed to $2.35bn in October from $4.32bn in September. Underpinning expectations that the trade balance narrowed last month is expectations that imports increased at a greater pace than exports. Bloomberg forecasts suggest that exports grew by 37% y/y in October, while imports surged 63% y/y. From a currency perspective, while Brazil’s trade surplus likely narrowed last month, the country’s terms of trade remain favourable, supported by elevated commodity prices. Brazil’s favourable terms of trade continue to bolster the BRL’s carry appeal and are helping to offset some of the bearish impetus in the currency

Mexico: Mexico is in the process of locking in its income from next year’s oil production, people familiar with the matter said, in what’s one of the most closely watched deals among the world’s energy traders. The oil coverage, a multi-million dollar deal that typically covers 200 to 300 million barrels, is so great that it often moves markets. Mexico has been buying put options in a price range of between $60 and $65 a barrel. As oil prices rise to multi-year highs, other producers have also seized the opportunity to secure future production. Note OPEC+ will be meeting on Thursday and is expected to stick to their current output plans.

On the data front today, investors will sink their teeth into the leading indicator and the nation’s weekly reserve balance. Though the leading indicator is slightly outdated, it may point to an improving economic outlook in Q4 2021. As highlighted with the Markit PMI gauge, challenges to the economy persist but have also indicated a resumption of the recovery. The indicator, alongside the preliminary Q3 GDP reading, will be used by the central bank in deciding on the future path of its interest rates..

Colombia: The Davivienda Colombia manufacturing PMI declined marginally from the highs reached in September, but remained deep in expansionary territory as the manufacturing sector continued to grow at the beginning of Q4. Specifically, the index dropped from 55.5 to 54.0, with new orders rising at a slightly slower pace as respondents deferred purchases amid elevated charges and shortages of items. Similarly, production rose at a slower pace due to capacity pressures and raw material scarcity, which led to a near-record increase in cost burdens. Still, companies continued to hire additional workers, purchased extra inputs, and remained overwhelmingly positive over the state of the sector. This was consistent with the broader improvement of the Colombian economy, but reflected growing risks that input restrictions might increasingly weigh on the performance of the economy in the coming months.

Today, the Colombian data card will be headlined by the minutes of BanRep's policy meeting last week. These will likely confirm that the Colombian central bank has embarked on a tightening cycle that will last through next year. Investors will diagnose the minutes for fresh insights into the magnitude of future hikes and the rate the bank is targeting at the end of the cycle.

Chile: Data released yesterday showed a local economy that remains very much on the boil. The economic activity reading for September came in at 15.6% versus a market expectation of 12.3%, granted it was lower than the 19.1% recorded in August but it still shows an economy that is powering ahead even following the doubling of interest rates by the BCCH from 0.75% to 1.50% on the 31st August 2021. Robust domestic demand is certainly evident and it remains to be seen whether or not the BCCH has managed to curb spending given its aggressive hike of 125 bpts at the October meeting, we will only see the impact of this at the October reading of economic activity. The weaker currency and higher copper price have certainly resulted in an improved terms of trade however the higher copper price has yet to translate to an increase in mining output.

Peru: Another minister from President Castillo's Cabinet has resigned with Interior Minister Barranzuela leaving his post yesterday following public uproar after he hosted a social gathering at his residence just days after his ministry had banned such gatherings. A new minister is expected to be announced very soon, according to President Castillo. Barranzuela's resignation and the appointment of a successor will, however, likely help the current Cabinet gain Congress's approval after several lawmakers had asked for the minister to be sacked. Congress will vote this week on whether or not to approve the Cabinet.

Forex: Tight trading expected ahead of the Fed

Brazil: With local markets shut yesterday, the focus this morning is on the USD. There has not been much change through yesterday's trading session, with investors treading water ahead of the labour data and the FOMC decision later today. The USD remains somewhat supported ahead of the FOMC meeting and the anticipated taper, but any dovish talk will see that rapidly unwind. Any fresh breakout of the current range will happen after the FOMC statement, which will offer perspective on how sensitive the FOMC will be to inflation. For the BRL, it should be a cautious open as a result.

Mexico: With the local market closed for a public holiday yesterday, the MXN rose by nearly 0.6% to close at 20.784/USD after losing almost 3.3% in the last five sessions due to a disappointing Q3 GDP reading that raised fears of slowing growth. Notably, the MXN was the second-best performer on the day among other emerging market currencies. The one-month, MXN implied volatility has slipped from a near a three-week high to 10.975% in today’s session so far. While global FX risk appetite remains cautious given the looming FOMC meeting, with the Fed is expected to announce its taper plans, the MXN has continued to gain against the USD. Additional gains could lead the local currency to retest the 20.700/USD handle.

Colombia: The COP started the new week off on the defensive, depreciating 0.75% against a broadly-stronger USD after the Colombian long-weekend. It started the day off positively as the market priced in BanRep's rate hike on Friday, but gradually lost its shine through the session as the USD strengthened in anticipation of the Fed's expected taper announcement later today. Consequently, the COP remained within the 3750/$-3800/$ range it has been trading in recently, with Friday's 50bps rate hike unable provide sufficient impetus for a break out of this tunnel.

Chile: It was another day of tight ranges and consolidation for the peso as investors waited on the sidelines for the big macro data releases this week. The short term cap seems to be 820 for now while the downside sees support evident at 800. Not much to report back on at present.

Peru: The USD-PEN gapped higher at the open yesterday as local markets reopened. The pair is now back above the 4.000 handle and could probe the 100DMA at 4.021 in the session ahead. We should see a more measured start to the local session today as investors will be waiting for the Fed announcements. Risks going into the meeting are skewed to the downside for the USD, given all that is priced in now. If the Fed is more dovish than expected it will provide a tailwind for emerging market FX heading into the latter half of the week.

Fixed Income: Banrep’s hike keeps flattening pressures embedded

Brazil: Brazilian markets were closed on account of a national holiday yesterday. Emerging market bonds for the most part traded in a consolidative manner yesterday with traders sitting on their hands ahead of the all-important FOMC rate announcement this evening. As mentioned above, the Federal Reserve is likely to begin tapering its bond-buying program, which has provided an unprecedented injection of dollars into the global financial system over the past year. The massive spike in global dollar liquidity has resulted in a massive flood of money into riskier emerging market assets this year, especially those that offer investors an attractive yield.

That said, while the Fed is expected to begin tapering its stimulus policies this evening, it is important to note that the central bank is merely lifting its foot off the accelerator pedal and is not yet applying the brakes. Given that the US’s economic recovery remains fragile, the Fed will have to balance reining in inflation without choking off the economy. As such, we only expect the Fed to begin hiking rates at the backend of next year or early 2023. Therefore, we expect global dollar liquidity to remain elevated in the coming months, which, as has been the case for the past year, should continue to support riskier emerging market assets in the months ahead.

Mexico: The local bond market was closed yesterday due to a public holiday. Pulling back the lens, the final quarter of the year has seen the sovereign bond curve bear flatten, with the front-end tenors rising by 110bps while belly and long-end yields have risen a modest 20bps. With the front-end likely to continue to respond to inflationary pressure against the backdrop of a moderating economic business cycle, it could result in the yield curve inverting in the months ahead, as seen with Latam peer, Brazil.

Colombia: As was to be expected after BanRep's larger-than-expected rate hike and improved economic growth outlook on Friday, the Colombian yield curve continued to flatten at the start of the new week. The 1-year bond added another 13.15bps to its yield through the session, while belly and long-end of the curve dropped as investors positioned for an improved fiscal outlook. Today, investors will digest the minutes of Friday's policy meeting for fresh directional cues, while the Fed's policy update and accompanying guidance is also expected to provide significant impetus.

Chile: There has not been much change through yesterday's trading session, with investors treading water ahead of the labour data and the FOMC decision later today. The USD remains somewhat supported ahead of the FOMC meeting and the anticipated taper, but any dovish talk will see that rapidly unwind. Any fresh breakout of the current range will happen after the FOMC statement, which will offer perspective on how sensitive the FOMC will be to inflation

Peru: Local currency government bonds weakened yesterday with yields rising across the board as trade resumed following the long weekend. The pressure stemmed from Monday's inflation print, as well as political concerns given the rising levels of unrest within the country's capital. The surge in inflation drove front end yields higher which kept some flattening pressure embedded along the curve. We expect this bias to continue over the near term, with focus today turning to the Fed announcements which may generate some volatility within global markets.