Morning Note /

Latam Daily: Peru markets react to S&P downgrade, hawkish Fed

  • Talking Points: Colombia and Brazil return from long weekends to markets roiled by the Fed

  • Forex: BRL continues to outperform its peers on surging inflows, breaks through 5.000/$

  • Fixed Income: Peru curve has room to flatten further

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

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

Talking Points: Colombia and Brazil return from long weekends to markets roiled by the Fed

Brazil: Developments on the domestic front were sparse yesterday. Things on the domestic front should pick up today with the BCB scheduled to publish its minutes from last week’s Copom meeting, where policymakers delivered a 100bps rate hike and pledged to deliver a hike of the same magnitude at its May meeting. The meeting minutes could help clarify the mixed messages from the Copom’s March policy statement. Therefore, the meeting minutes have the potential to result in fresh price action for domestic assets.

Also potentially on tap today is the March tax collections data. Recall that recent fiscal data has been upbeat, helping ease concerns over the popularist shift in policy ahead of the October presidential elections.

According to the latest weekly ETF data compiled by Bloomberg, Brazil remains a favoured destination for foreign investors. Specifically, Investors injected $81mn into the $5.9bn Ishares MSCI Brazil ETF last week, the most since mid-December. As mentioned in previous commentary, Brazilian assets, equities in particular, are among the favourite bets of global money managers who are enticed by the massive undervaluation in domestic assets following years of underperformance. Note that Brazilian assets are also benefitting from elevated commodity prices and Russia’s expulsion from key emerging market indices. Foreigners are also taking advantage of the most attractive carry trade on offer in the emerging market space with the BRL score the highest in ETM’s carry trade model

Mexico: Mexican President Lopez Obrador on Monday inaugurated a new international airport aimed at relieving the congestion at the long-serving Mexico City International Airport. The new Felipe Angeles International Airport (AIFA), rebuilt at the Santa Lucia Air Force Base, is one of the president's flagship infrastructure projects to finish before his term ends in 2024. However, the new airport opened before road and rail links were completed. The government has stated that any carriers that want to schedule new flights to Mexico City will be required to use the new airport rather than the older and closer airport.

The local market is in for an action-packed short trading week, with several top-tier economic releases poised to move markets. Banamex’s survey of economists will kick things off, followed by bi-weekly inflation figures, retail sales, monthly economic activity and a rate decision. While the market is positioning itself for a 50bps rate by Banxico this week, the survey of economists will provide further insight into policy tightening and inflation expectations in the coming months. Any additional insight into economic growth will also be of importance

Colombia: Economic activity stats for January released out of Colombia on Friday came out more or less as expected, reflecting continued year-on-year growth, but a marked month-on-month decline at the start of the year. Specifically, the economic activity gauge grew 7.8% y/y despite a 2.2% m/m contraction, mirroring what was seen in manufacturing output and retail sales data released earlier last week. The month-on-month declines reflected the impact of the most recent COVID-19 wave that hit Colombia in January, but also pointed to broader headwinds the economy is facing in the form of red-hot inflation and tightening financing conditions.

Trade account data, meanwhile, showed Colombia's trade deficit widened from $1.27bn to $1.70bn in January, with this high number a function of still-elevated import demand. Colombia's wide trade deficit remains a strong headwind for the COP, and alongside the country's budget deficit, detracts from its broader investment attractiveness. This supports the argument for BanRep to hike interest rates in the months ahead to prevent financial market instability as global financing conditions tighten.

On the political front, note that Colombia's top electoral body ordered a recount of votes from Senate elections earlier this month due to a large number of fraud accusations. Presidential frontrunner Gustavo Petro claimed nearly 400,000 votes for leftist candidates in the Senate were not counted, which would add significantly to the already-high number of seats his leftist coalition won in the upper house. Similarly, right-wing parties also requested a recount, saying that the results fomented mistrust in the election process. The recount is significant as it could alter the kind of congress the incoming government will need to deal with to pass legislation in the coming years, while it may also polarise the electorate even more and foster distrust in the electoral process.

Chile: The world is grappling with higher fuel prices and Chile is no exception. Globally governments are concerned that sustained higher energy costs will lead to social instability as households battle to make ends meet as a result of the rampant energy costs. It was thus not surprising to see the Chilean government responding quickly by sending a bill to congress yesterday where they aim to double the amount available from a fund designed to cushion the blow of higher fuel prices. The amount targeted is $1.5bn, and Finance Minister Mario Marcel stated that it could be debated immediately in Chile's lower chamber of deputies given that the Fuel Price Stabilization Mechanism was running low on funds and may not be able to fill its mandate of smoothing energy price increases. Reuters reported the FinMin as saying the following - "If these resources are not expanded, fuel prices would have to rise significantly in the coming weeks," Marcel told reporters. "This is going to allow this stabilization mechanism to continue operating throughout the rest of the year."

Peru: Mining firm MMG has said that operations at its Las Bambas mine have resumed as local communities have lifted blockades, allowing deliveries of semi-processed materials. Copper deliveries are resuming to Peru's ports as a result, with the mining firm and the community in a 30-day truce following sporadic disruptions as negotiations have failed to lead to a final compromise. Although operations have now returned to somewhat normal conditions, there is always the risk that the blockades could return if the ongoing negotiations falter. This highlights the volatile nature of Peru's mining sector investment outlook at the moment, and the urgency at which agreements need to be made between miners and local communities.

This was none the more pertinent yesterday when another local community group threatened to halt operations at PetroTal's block 95, an oilfield located in the region of Loreto. The community is protesting against the militarization of indigenous territories, which they claim is repression against local communities. The community has threatened that oil activity in the block will be shut and that the impeachment of President Castillo will be demanded, just a week before the debate on this motion is set to take place in Congress. PetroTal has reduced its oil output in the block since the end of February, and could shut down even more given the new threats.

Forex: BRL continues to outperform its peers on surging inflows, breaks through 5.000/$

Brazil: After several unsustained probes below the 5.0000 handle, the mighty BRL managed to sustain a break below the key level on Monday. For context, the BRL gained 1.74% against the USD yesterday to end the session at 4.9360, according to Bloomberg data. Given that there were no clear domestic drivers behind the move lower in the BRL, it suggests that the rally was fueled by foreign capital inflows as higher commodity prices improve the country’s terms of trade. The moves over the past 3 sessions suggest that the bullish bias in the BRL has resumed. That said, the USD has strengthened this morning on the back of the hawkish comments from Fed Chair Powell overnight, suggesting that the BRL could come under some pressure at the start of the session.

Mexico: In wrapping up last week, the MXN outperformed its Latam peers, closing above the near-term barrier, the 200DMA at 20.3617/USD. The currency traded at its strongest level since the start of the month and printed its biggest weekly advance against the USD in three months as traders remain optimistic about the end of the war in Ukraine. In holiday-thinned trading yesterday, the MXN continued to trade on the front foot, extending its advance to seven successive days – its longest winning streak since September. The MXN has come under pressure this morning as the market reacts to Fed Chair Powell’s remarks overnight. Notably, the one-month USD-MXN implied volatility has risen above the 11% mark, after trending lower in the past ten sessions to the lowest since Feb 25, shortly after the war in Ukraine broke out.

Investors turned net short the Mexican peso last week after going long the currency for six straight weeks, according to CFTC data. Developments in Ukraine and their impact on commodity prices have been a significant driver of direction, and that is not about to end anytime soon. As is the case with many other emerging market currencies, the MXN is likely to remain volatile, although given just how uncertain the geopolitical situation is, it is unlikely that investors will adopt any convicted trading strategy. Moreover, traders are also beginning to pay more attention to the growing COVID contagion in Europe and virus-related shutdowns of Chinese cities that could hit demand and supply..

Colombia: A 0.20% advance on Friday meant the COP closed last week flat on aggregate, reflecting broader rangebound trade it has been subject to since breaking above the 3800.00/$ mark earlier in the month. Leading into the new trading week, the market will need to weigh yesterday's oil-price rise against Fed Chairman Powell's hawkish rhetoric. Ultimately, this could lead to the USD-COP remaining within its consolidatory tunnel for a while longer, as the bulls and bears battle it out to kickstart a new trend.

Chile: The local unit had an impressive day yesterday despite the hawkish tone from the Fed which ordinarily favours the dollar leg of the equation. The USD-CLP broke below the 200DMA at 797.10 to close at 793.88 which does open the door for a test of the 50% retracement level at 782.75 should the current bullish tone be maintained..

Peru: The PEN underperformed its peers yesterday as the market reacted to the S&P credit rating downgrade. The local unit lost around 0.2% against the USD after paring some of its initial losses, which saw it test the key 3.8000 support level which currently coincides with the 50DMA. The bias is clearly with the PEN bears at the moment and could see further testes of this key level in the coming sessions, especially as political uncertainty ramps up ahead of next week's impeachment debate.

Fixed Income: Peru curve has room to flatten further

Brazil: The sell-off in global bonds deepened on Monday after the Federal Reserve Chair delivered his most hawkish message during the Covid-era as the US economy continues to battle soaring inflation. Powell said that the Fed is prepared to raise interest rates by 50bps at the next policy meeting if conditions require. Recall that the Fed hiked rates by 25bps at its March meeting and signalled that it would deliver six more hikes of the same magnitude in the remaining months of this year.

The hawkish rhetoric of Powell’s comments overnight has added to the bearish bias in the global bond market, with the 2yr US Treasury yield surging to its highest level in almost 3 years this morning. At the time of writing, the 2yr US Treasury yield was trading at 2.18%. This means that the shorter-dated 2yr US Treasury yield has climbed 145bps since the start of the year, reflecting the marked shift in US monetary policy as inflation pressures continue to surge. Brazilian bonds also kicked off the new week on the back foot with yields across the curve closing the session higher. For context, the 2yr and 10yr Brazilian bond yields rose 10bps and 6bps to close the day at 12.77% and 12.21%, respectively.

Following Powell’s comments, the US derivatives market had priced in nearly 190bps of rate hike risk for the remaining six FOMC meetings this year, implying that the market is baking in the risk of more than one 50bps rate hike. While traders scaled up their bets for a more hawkish policy path in the US, expectations are mounting that China will loosen monetary policy to support its ailing economy

In conclusion, given that inflation is proving to be stickier than central banks had anticipated and the shift in policy from central banks around the globe, the bear flattening bias in bond markets across the world is expected to persist. Adding to this noting is lingering growth concerns, which should continue to anchor longer-dated bond yields.

Mexico: The domestic bond market was shuttered yesterday for a public holiday. Investors will return to a deepening global bond market selloff after the Federal Reserve Chair delivered his most hawkish message during the Covid-era as the US economy grapples with soaring inflation. Powell said that the Fed is prepared to raise interest rates by 50bps at the next policy meeting if conditions require. With persistent inflationary pressure lasting longer than central banks had anticipated and the shift in policy from central banks globally, we could see the bear flattening bias in global bond markets persisting. Moreover, lingering growth concerns should continue to anchor longer-dated bond yields. The Mexican central bank is expected to hike rates by 50bps this week, supporting this narrative. Note that the MXN yield curve is trading flat from the 3yr bond out to the 30yr bond this month.

Colombia: A recovery in demand between Tuesday and Friday meant the Colombian yield curve ended last week more or less flat, suggesting the market was generally comfortable with the amount of BanRep rate-hike risk priced into the short-end, and political and economic growth risk priced into the long-end. Whether this remains the case following the long weekend remains to be seen, however, as investors digest increased hawkishness from the US Federal Reserve and the prospect of a faster tightening of global financing conditions.

Chile: The potential for another round of pension fund withdrawals, however remote coupled with the uncertainty of the constitutional rewrite are two factors which plague fund managers wishing to go long Chilean bonds. These two factors add an additional layer of complexity to an already difficult market that is grappling with a slowing economy and higher inflation dynamics, especially in the short term. We remain of the view that payers will hold the upper hand for the foreseeable future, however the level of curve inversion may start to slow should we receive strong guidance on the direction for rates at the next BCCH meeting in one week’s time.

Peru: Peruvian government bonds received a double blow yesterday, as the market reacted to S&P's downgrade and surging UST yields following Fed Chair Powell's suggestions that a 50bp rate hike could be on the cards in the US. Unsurprisingly, the front-end underperformed as this bolsters the case for a potentially more aggressive pace of policy tightening locally. We expect that this flattening pressure along the curve may persist for now, especially given that Peru's curve remains relatively compared to many of its peers. The current 10v2 spread for Peru is around 256bp, with Colombia's near 98bp and Chile's around 70bp. The Brazilian yield curve, meanwhile, is already inverted