Morning Note /

Latam Daily: Peru political crisis deepens as protests engulf Lima

  • Talking Points: Rising regional inflation threatens more social disruptions

  • Forex: BRL outperformance continues, PEN may be pressured amid renewed unrest

  • Fixed Income: Colombian bonds cheer poll results, less hawkish central bank

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Danny Greeff
Daron Hendricks
Kieran Siney
ETM Analytics
5 April 2022
Published byETM Analytics

Talking Points: Rising regional inflation threatens more social disruptions

Brazil: Traders have the latest services PMI and vehicle sales data to contend with today. While the services sector was arguably the hardest hit by the pandemic, the sector has staged a remarkable recovery in recent months amid the easing of lockdown measures and the reopening of the economy. PMI data suggests that the recovery in the services sector is likely to be sustained in the months ahead.

Also of interest today for traders is the weekly linker auction, which has the potential to result in fresh price action in the secondary bond market. National Treasury plans to sell Selic-linked LFT bonds maturing in 2028 and inflation-linked NTN-B bonds maturing in 2025, 2032 and 2045. With inflation risks still skewed firmly to the upside, we expect demand for inflation protection through inflation-linked bonds to remain healthy.

Mexico: The Finance Ministry’s recent economic growth forecast of 3.4% for this year appears to be too optimistic and has caught the eye of Fitch Ratings Agency yesterday, which stated it does not see GDP hitting pre-pandemic levels until 2023. Suppose Mexico cannot hit its growth forecast. In that case, it will need to cut spending to ensure deficit targets are met, as Mexico has a “prudent fiscal policy aiming at a zero primary balance consistent with a stable debt burden as a percentage of GDP,” Fitch wrote in its note. The rebound from the pandemic-induced recession across Latin American countries is taking longer than projected, and Mexico's growth is no different as it remains slow and steady, but generally disappointing. Mexico has a rating of BBB- with a stable outlook by Fitch. Although precarious as the government takes on the Pemex burden, the rating remains investment grade which amongst emerging markets is something to prize and protect. The stable rating suggests there is no immediate danger of a downgrade, although that could change.

Colombia: The minutes from BanRep’s March policy meeting, released yesterday, pointed to consensus among policymakers to continue tightening monetary policy as a means to keep inflation expectations tethered to the target. Perhaps more interesting were the reasons five of the seven board members voted in favour of a 100bp rather than an expected 150bps rate hike: they noted that the relatively smaller but still significant rate increase was prudent considering the level of global uncertainty and the need to recover jobs through sustained economic growth. Those who voted for the relatively larger 150bp rate hike, meanwhile, maintained that the economy was still very robust and that labour-market indicators had improved, while also signalling concern over an accelerated tightening of global financing conditions

Against this backdrop of growing uncertainty over Colombia’s monetary policy outlook, the market will have March CPI data to digest today. The consensus expectation as per Bloomberg surveys is for inflation to have accelerated from 8.01% y/y to 8.48% y/y in the final month of Q1, driven higher by both core and non-core components.

Chile: President Gabriel Boric has vowed to work with his Chilean neighbours on economic, energy and cultural matters. Boric was visiting Argentine President Alberto Fernandez in his first trip abroad since taking the role in March. Reuters reported - "We have challenges that are deeply shared," Boric said at a joint news conference with the Argentine president in Buenos Aires. Argentina's economy minister, Martin Guzman, and Chile's energy minister, Claudio Huepe Minoletti, signed a joint declaration addressing issues of integration and bilateral energy cooperation. "Guzman and Huepe discussed the commercialization of natural gas, the Argentine export of LNG (liquefied natural gas) and oil, and the rehabilitation of the Neuquen-Biobio pipeline," a statement from the Argentine treasury said. In the mid-2000s, after its own supply faltered, the Argentine government cut off crucial gas exports to Chile, triggering a diplomatic crisis.

Meanwhile, Chilean copper output has fallen sharply in February, the government body Cochilco announced yesterday. Total production fell by 7.5% on the month to 394 700 tonnes. The state owned mine Codelco was the only one to post a positive production number edging up 0.7% year on year to 123 600 tonnes, while Escondida fell by 14.3% year on year to 69 900 tonnes and Collahuasi recorded a drop of 11.2% to 46 900 tonnes.

Peru: Peru has announced a new curfew in the capital of Lima following violent protests against rising inflation. The city is now in a state of emergency, alongside the port city of Callao, following bus driver blockades which kick-started the protests as many believe that the recent measures announced by the government are not enough to help the poor fight the surging cost of living. Despite the curfew, Congress will still hold a session today where they will meet with President Castillo in an effort to address the protests and come to a solution to fight inflation. Congress is looking to have the president lead the crisis, a play that may lead to diminished public support for him, which will help those looking to impeach him.

The ongoing strikes will deliver another blow to the economic recovery, with industry groups already warning that agri exports cannot be delivered to the protests and road blockades. Shops have been looted and the army has been deployed as a result to attempt to calm things down. This is another major headwind that the economy faces, just as economic growth was showing signs of slowing already. The strikes will likely continue at least through the day ahead, with many waiting to see what the government will announce.

Forex: BRL outperformance continues, PEN may be pressured amid renewed unrest

Brazil: The rally in the BRL persisted at the start of the new week as capital flows continued to pour into the country as the combination of high rates and soaring commodity prices bolstered the currency’s carry appeal. Note that investors have been piling into Brazilian assets this year, taking advantage of the attractive valuations. Data from the B3 showed that Brazilian equities saw a foreign inflow of around BRL 65.3bn in the first three months of 2022. This marked the largest net quarterly inflow in more than a decade.

The BRL was the second best performing emerging market currency on Monday, outperformed only by the Russian Ruble. The BRL ended the session 1.45% stronger against the USD at a fresh year-to-date low of 4.5928, according to Bloomberg data.

The latest CFTC data revealed that futures traders remain decisively bullish on the BRL, notwithstanding the extended rally in the currency. For context, BRL net longs edged higher to $890mn in the week ending March 29. Although the futures market remains bullish on the BRL, local traders have increased their hedges against the BRL amid fears that the recent rally is overdone..

Mexico: The bearish momentum for the USD-MXN remains entrenched as it retreated for the fifth straight session on Monday, in line with moves across the region to reach its lowest level since June last year at 19.7274. The downside impetus remains in place in pre-market trade and is being driven in part by broad dollar weakness. After three consecutive daily advances, the bid tone of the USD appears to have lost some momentum just ahead of the 99.00 barrier. This opens the door for the USD-MXN to probe its 2021 low of 19.549, last seen on Jan. 21. There is no technical resistance in the way of the MXN bulls, so as long as the USD remains on the backfoot or trades in a consolidatory fashion, the move lower should not be constrained.

The latest CFTC data showed the outright bearishness on the MXN weakened last week in the build-up to a rate decision that was well telegraphed for a 50bps rate increase, which should be evident in the upcoming CFTC report. Looking ahead, these short positions are likely to unwind as the MXN continues to strengthen against the USD. Positioning on the MXN, however, is unlikely to be outright bullish until global financial market conditions stabilise.

Colombia: The COP started the new week off on a very strong footing, appreciating 1.30% against a broadly stronger USD yesterday. This followed as the market cheered poll results showing leftist presidential candidate Gustavo Petro was losing support, while rising oil prices also provided support. Yesterday’s advance took the COP to levels not seen since June 2021, although a failure to sustain a break through the 3700/$ mark suggests this may be the first point of resistance in the session ahead.

Chile: The USD-CLP is currently contained in a tight trading range of 771.90 to the bottom and 791.50 to the top. The local unit appreciated by some 0.36% on the day yesterday as the LATAM complex in general remained bid against the greenback. Investors are rotating emerging market exposure away from Eastern Europe and this is assisting the region as a whole with investors finding the risk more palatable.

Peru: The USD-PEN touched a low of 3.6145 yesterday before reversing to unwind these losses and post a marginal gain on the session as local protests took centre stage. The central bank also intervened in the market to try and calm volatility. With the protests and a resurgence of some political volatility, the recent lows may end up being a near-term floor for the currency pair, attracting USD-buying unless we start to see the situation calm down.

Fixed Income: Colombian bonds cheer poll results, less hawkish central bank

Brazil: The hawkish pivot from developed market central banks in recent months has come as a stern headwind for emerging market sovereign debt as the market prices for higher interest rates across the globe. The hawkish shift in monetary policy has been broad-based, with central banks ranging from the Federal Reserve to the BCB raising interest rates as rising food and energy prices fuel inflation. Tightening financial conditions is the main risk facing emerging market bonds, with rising US Treasury yields eroding a significant portion of total emerging market bond returns in 2022. According to Bloomberg data, emerging market bonds have lost on average 9.16% since the start of the year. Compounding the risks for emerging market bonds has been uncertainty and inflation risks over the war in Ukraine.

Another factor contributing to the sizeable losses in emerging market debt this year has duration-related pressures. Note that duration measures the level, slope and shape of emerging market bond curves, while spread risk reflects credit fundamentals and factors such as liquidity or lack thereof in the secondary market. According to Bloomberg’s calculations, duration risk has eroded around 700bps from the performance of emerging market debt since August 2021, just before the significant shift in global monetary policy began.

In line with the US Treasury curve, shorter-dated and medium dated emerging market bonds are underperforming this year as interest rates across the world rise. Emerging market bond returns could come under additional selling pressure if inflation pressures rise further as central banks will be forced to turn more aggressive. Looking ahead, with inflation pressures set to remain acute against the backdrop of heightened uncertainty surrounding the war in Ukraine and the covid situation in China, we expect emerging market bonds to remain under pressure in the months ahead. Moreover, the broader flattening bias in the fixed income market is expected to persist.

Mexico: MXN bonds were offered yesterday, with yields rising by 4bps to 6bps on the belly and long-end of the bond curve. Bond yields rose as a result of concerns about economic growth, a persistent surge in US Treasury yields, and higher oil prices. Inflation remains a concern for the domestic market, which the geopolitical risks have exacerbated. While Mexico is not highly sensitive to the effects of the conflict, it does raise stagflation concerns as rising energy prices and supply threaten household and corporate income, which raises the likelihood of slower growth and sovereign rating changes. Fitch has already noted its less optimism about Mexico’s medium-term economic growth. This is something for traders to keep in mind, as long-end bonds are expected to remain supported.

Colombia: The Colombian bond market cheered recent poll results that showed leftist Senator Gustavo Petro no longer enjoys a clear lead in the upcoming presidential elections, with the race tightening between him and conservative candidate Federico Gutierrez. Yields dropped sharply across the curve on Monday as investors were reassured by the apparent decline in Petro’s popularity, as he has spooked markets in recent months with policy plans to end oil exploration and raise import tariffs. The 5-year bond led the charge, shedding more than 40bps from its yield through yesterday’s session, with most other tenors shedding more than 28bps on the day.

Chile: The unwinding of bond shorts continues unabated. Pulling back the lens it is worth taking a look at how far we have come over the past week in certain tenors. The 2023 bond has shed around 88 bpts, marked at 7.77% on the 28th March versus a close yesterday of 6.89% while the longer dated 2030 paper has shed 40 bpts to the downside. This has allowed the curve to temper its inversion trend massively and the trend is likely to continue in the coming days with a break of -60 bpts in terms of 2030-2023 not out of the question.

Peru: Local government bonds continued to weaken yesterday, flattening out the curve as the front end underperformed amid possible rising bets that the central bank will remain hawkish at its meeting this week. The ongoing protests and elevated inflation expectations will remain a drag on the market, while investors may start to price in more political volatility ahead, given the ramifications these protests could have for the president and his government. Some deterioration in fiscal prudence is also on the cards, given that the government is being pressured into intervening to contain inflation, likely by creating further subsidies and income supplementation measures.