Morning Note /

Latam Daily: More rate hikes expected this week but hawkishness may be overdone

  • Talking Points: Colombia, Chile and Peru all to hike further this week

  • Forex: Regional currencies keep benefitting from rising commodities

  • Fixed Income: Hawkish central banks to underpin curve flattening

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Danny Greeff
Daron Hendricks
Kieran Siney
ETM Analytics
28 March 2022
Published byETM Analytics

Talking Points: Colombia, Chile and Peru all to hike further this week

Brazil: While the central bank has communicated that its base case scenario is to end its hiking cycle in May, the stronger than expected mid-month inflation print released on Friday bolstered bets that the BCB could hike rates further in subsequent meetings. For context, consumer prices rose by 10.79% y/y in the first half of March, up marginally from 10.76% y/y in the first two weeks of last month. On a month-on-month basis, inflation rose 0.95% compared to consensus expectations of 0.85%. Once again, inflation was fuelled by soaring food and transport prices.

BCB President Campos Neto said last week that inflation is expected to peak in April and then ease toward the central bank’s 3.50% inflation target in the following months. Economists have signalled that inflation is expected to remain high for the foreseeable future due to the supply disruptions caused by the war in Ukraine.

Although inflation is expected to remain elevated in the coming months, given the high base effects, tightening credit dynamics and subdued economic outlook, we expect to see disinflation in 2023. As such, with rates already buoyed in positive and restrictive territory, we don’t see a need for the central bank to raise rates higher than what is currently priced, given how aggressively the BCB has hiked rates over the past 12 months.

Mexico: Mexico will maintain a balanced budget while subsidising gasoline prices, even if the price of crude oil spikes to $155 per barrel, according to Finance Minister Rogelio Ramirez de la O in last week’s annual banking conference. News that the government can keep providing tax relief on petroleum even if the cost of gasoline and diesel rises far higher than its current level. That would allow the government to maintain low prices and protect consumers despite energy costs surging in the wake of Russia’s invasion of Ukraine. The government recently expanded a temporary exemption on the excise tax generally imposed on gasoline to contain the spike in prices. The government has estimated that it could cover the full cost of the tax in scenarios in which a barrel of the Mexican crude oil mix stands at $95, $105 or $155. Mexico’s accounts will stay balanced unless crude prices fall while overall fuel prices rise, a scenario he said would be a unique historical event.

The new week gets off to a slow start with monthly trade data in both Mexico and US scheduled for release. Mexico’s February trade deficit is forecasted to have narrowed to $219mn, compared with a gap of $6.28bn from the previous month, owing to higher exports and lower imports. The result should still imply strong year-on-year growth, with imports above their level prior to the outbreak and in line with recovering domestic demand. High oil and gas prices will bolster imports in the months ahead, implying a favourable trade balance and current account remain some way off.

Colombia: Presidential candidate Gutierrez has named Rodrigo Lara Sanchez as his running mate for this year's elections. Lara was mayor of Nieva from 2016 to 2019 and is a qualified surgeon. It is unclear at this point if he will provide enough additional support to see Gutierrez close the gap on former Bogota mayor Petro's current lead in the polls, although his mayorship was deemed successful. He has extensive experience in dealing with the healthcare and education sectors, which should speak to a positive reception for him from the more left-leaning centrists that could help Gutierrez at the final vote.

The current global macroeconomic backdrop is highly uncertain, and this is leading to a major hawkish for central banks in both the developed and developing market spaces. Our view, however, is that this hawkishness is overdone currently, with notable disinflationary forces expected to exert themselves through the final months of 2022 and into 2023, including high base effects for inflation and slowing growth due to tightening financial market conditions.

Against this backdrop, we have the next local central bank decision, which will take place on Thursday. Expectation is that Banrep will hike by 150bp and keep the door open towards more amid rising price pressures and improving economic activity. More details regarding the previous rate hike and the outlook going forward are below in the interest rate outlook section..

Chile: The start of the week is thin on the data side however investors will be gearing up for the BCCH decision on rates. This the first sitting of the new administration under governor Rosanna Costa. It is worth noting that at the January meeting, policy members debated whether or not to raise rates by 125, 150 or 175 bpts before settling on the 150 bpts. Consensus for the meeting tomorrow is for a 175 bpt hike which will take the overnight rate to 7.25% from 5.50%. The risk according to the trading desks is for an outsized hike of 200 bpts.

Wednesday will see the BCCH releasing its quarterly inflation report which will give insight into the bank’s thinking on growth and inflation as well as the broader direction of monetary policy going forward. What will be important to dissect is how the bank has changed its growth and inflation projections as a result of the Ukrainian/Russian war and the dislocations in commodity markets

Peru: It is a big day ahead for Peru as President Castillo is scheduled to defend himself in front of Congress before the impeachment debate against him begins. This is the second attempt against him in four months, but this time it could be a lot closer given the number of lawmakers that have recently said that they will back the motion. Recall that 87 votes will be needed for Castillo to be ousted.

Meanwhile, the community blockade at MMG's Las Bambas mine has been lifted, with the community and the mine reaching an agreement according to the government. This agreement came after police were sent to the corridor in order to prevent an escalation and maintain stability. The lifting of the blockade is a positive step, but several protests remain around the country and will continue to pop up unless more sweeping changes are announced by the government.

Forex: Regional currencies keep benefitting from rising commodities

Brazil: Currency bulls were out in full force last week, with the BRL staging one of its best weekly performances in recent years. The combination of the local currency’s attractive carry appeal and rally in commodities saw the BRL gain an impressive 5.58% against the USD last week, closing Friday’s session at 4.7429, according to Bloomberg data. As mentioned last week, while local traders are scaling up their hedges on the BRL, given how extended the rally has been, we still see room for further appreciation in the local currency if the rally in international commodity prices holds up. Notwithstanding the sharp appreciation in the BRL in recent weeks, the BRL is still significantly undervalued.

Mexico: On Friday, the MXN climbed for the eleventh day in a row, posting its longest winning streak against the USD since 1971 and breaking through the psychological 20.00/USD level last seen in September of last year. This brings the MXN's gains this month to 2.95%, making it the fifth best-performing emerging market currency out of twenty-four tracked by Bloomberg during that period, only lagging the Russian ruble, the Brazilian real (BRL), the South African Rand (ZAR) and the Chilean Peso. Note that the MXN is 3% overvalued based on ETM Analytics' in-house proprietary model, less than 4% of the ZAR and 6% of the BRL. The local currency’s attractiveness has improved following the central bank's rate hike last week.

The USD has jumped at the start of the new week, surging back up to 99.186 and looks set to trade at these stronger levels as markets continue to bet on multiple 50bps interest rate hikes by the Federal Reserve this year. As a result, the MXN has come under renewed pressure and may serve as a catalyst for a reversal given the overdone rally. If sellers book profits, the local currency may fall towards the 200DMA at 20.4184/USD, the first major support.

Colombia: The USD-COP remained below the 3800 level on Friday, keeping to within a fairly tight trading range that we have seen since the start of March. Momentum remains lacking at the moment and we could see this persist over the coming sessions ahead of the Banrep meeting. If the central bank hikes by the 150bp as expected and signals more hikes are to come, the pair may find it the catalyst needed to break below 3750. .

Chile: The peso remained on the front foot yesterday as investors now priced for an aggressive stance to monetary policy from the central bank this week. The currency finished the Friday session at 778.10. The next major support level for the USD-CLP comes in at 761,30 which is the 61.8% fibo retracement level. Ahead of the local open we have seen the emerging market FX complex trade mixed; we expect a measured start to the session and favour selling the upticks for now.

Peru: The PEN closed last week at 3.7424 to the USD, weakening on Friday to underperform its Latam peers on the session. Investors will have closed out some of their positions heading into today's impeachment debate against President Castillo. Given how long this debate may take, we could see a fairly measured session today for the local unit. The risk of an impeachment has not been priced in, so if Castillo is ousted, we could expect to see some notable volatility for the currency. If he survives, the currency may retest the 3.7000 dollar support level.

Fixed Income: Hawkish central banks to underpin curve flattening

Brazil: While near term inflation risks remain acute with global supply chain issues set to persist, there was a strong receiver bias in the swap market last week as traders readjusted their rate bets following the dovish remarks from BCB President Campos Neto. Rates across the curve fell sharply last week, with the 2yr and 10yr rates both falling more than 50bps. Following last week’s move, swaps have effectively reversed all of the topside moves following the market fallout following Russia’s invasion of Ukraine, which began on February 24. Since their respective peaks reached earlier this month, the 2yr rate is down 118bps while the 10yr is down 85bps.

Mexico: Domestic bond yields extended their climb into the weekend. The yield curve shifted broadly higher over the week, which may persist as the global bond market selloff shows no signs of abating as investors anticipate a looming policy tightening cycle by major central banks. The relentless rise in US Treasury yields is being driven by surprisingly hawkish comments from Fed Chair Powell and his rate-setting colleagues last week. This may continue as long as the Ukraine war drags on, bolstering inflationary fears and the need for tighter policy settings. Notably, Ukrainian and Russian authorities are scheduled to meet in Turkey this week for new peace negotiations, which might alleviate some of these fears if sufficient progress is achieved. For the time being, the bear flattening bias exhibited since the beginning of the month and year is expected to continue, even more so if the MXN weakens.

Colombia: Local bonds suffered on Friday as the global bond rout extended. Yields were up across the board, with the long-end underperforming despite the market continuing to price in greater short-term inflationary pressures that will lead to higher interest rates. Longer-dated bonds remain vulnerable to fiscal and political concerns given the upcoming elections, although we expect to see flattening pressures re-exert themselves once again, especially in the build-up to this week's Banrep meeting. The IBR curve also climbed sharply on Friday, reflecting the weakness seen across fixed-income assets and rising expectations for further rate hikes. As we note above, however, the current level of hawkishness globally seems overdone at the moment, suggesting that rates may be looking attractive to receivers at the moment..

Chile: The trend for higher bond yields remains firmly entrenched. The 2025 bond has risen by 210 bpts since the start of 2022, while the longer dated 2032 bond has shed around 70 bpts resulting in sharp curve inversion. As it stands, we do not expect much change in the trajectory with investors preferring the comfort of the fence ahead of the BCCH decision on rates tomorrow, the QIR on Wednesday and then Retail Sales on Thursday. All of these “events” have the ability to alter the market’s perception on the direction of economy and thus the shape of the yield curve.

Peru: Local bonds suffered on Friday as the global bond rout extended. Yields were up across the board, with the front-end underperforming as the market continues to price in greater short-term inflationary pressures that will lead to higher interest rates. This flattening pressure may persist over the near term, given the growth implications of tighter monetary policy and higher inflation. The latam region, however, may still perform better than the likes of Europe, given the commodity-linkages. So far, Peru's bond market has returned 1.86% this year on a USD basis, according to Bloomberg's Barclay's index.