Morning Note /

Latam Daily: Regional growth outlook continues to deteriorate

  • Talking Points: Peru to hike rates as protests over inflation persist

  • Forex: Latam FX bulls bailing as Fed tightening set to accelerate

  • Fixed Income: Inversion trade resurfaces following hawkish Fed minutes

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

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

Talking Points: Peru to hike rates as protests over inflation persist

Brazil: There is a dearth of economic data out of Brazil today. However, we do have the weekly bond auction, which could result in some price action in the secondary bond market. That said, local markets will likely take much of their direction from external developments. Given the sensitivity of financial markets to monetary policy dynamics at the moment, investors should keep an eye on the news scroller for comments from the Fed today, with Bullard, Bostic and Evans all scheduled to speak.

Domestic headlines were once again bombarded by news flow relating to Petrobras. The Energy Ministry announced the nomination of Jose Mauro Ferreira Coelho for CEO of Petrobras. Coelho is currently the chairman of PPSA, a state company that represents the government’s interest in pre-salt projects and has worked in the public sector for fourteen years, including as secretary for oil under the current administration. Recall that Coelho left the government last year after President Jair Bolsonaro announced inflationary spending plans that dampened investor sentiment.

Mexico: Following the release of the FOMC meeting minutes overnight, investors' focus will shift to Mexico's inflation prints and the meeting minutes from last month's rate decision. With consumer prices expected to have risen in March, due to a sharp increase in energy and food prices, the meeting minutes may provide insight into the official's thinking about risks from the war in Ukraine and increasing US interest rates. Policymakers may present their views on additional tightening monetary conditions while weighing up economic activity that remains weak and below potential.

Investors are also reminded that Mexico’s Supreme Court will resume its debate on electricity reform later today.

Meanwhile, gross fixed investment (GFI) in Mexico accelerated at the start of the year due to increased spending in non-residential construction, according to data published by the National Statistics Agency (INEGI) yesterday. Specifically, GFI rose to 8.6% y/y in January, advancing from a 7.6% y/y increase in the previous month and above market expectations for a less pronounced increase of 4% y/y. The latest figure marked elven successive monthly increases and remains well above historical levels. It should be noted that the y/y figures are still supported by base effects. According to INEGI, construction rose to a six-month high of 10% y/y, while spending on machinery and equipment increased by 6.6% y/y, its weakest growth in a run of eleven straight increases

Colombia: Conservative presidential candidate Federico Gutierrez maintained that Colombia’s weak fiscal position is making it hard to help the poor without strong economic growth and job creation. In his manifesto, published yesterday, Gutierrez said he’ll target economic growth of 5% through labour-market reforms and an investment drive, and seek to cut Colombia’s debt burden to 61% of GDP by 2026 with austerity measures if he wins the upcoming elections.

Chile: There is a deluge of data due locally surrounding trade. The trade balance came in at a revised $246m surplus in February, and there is expected to be a surplus of around $150m for the March print with preliminary figures showing higher shipments of manufactured goods. That said, mining exports are going to be a drag on the figure as they are forecast to remain below levels recorded a year ago despite the higher commodity prices. Copper exports will thus be watched closely as these are expected to show a decline

Peru: The BCRP will be meeting today amid ongoing protests that have erupted owing to rising inflation. Against this backdrop, we should see policymakers opt for another 50bp rate hike, despite the fact that we have seen smaller than expected rate hikes in the likes of Chile and Colombia recently. The risk of this occurring in Peru is much less significant given that the starting point for the expected hike is much smaller at just 50bp. The BCRP will also likely maintain its forward guidance, signaling more tightening to come as rates remain accommodative at the moment. There may be some reference to a weaker growth outlook and economic slack, but this will merely contain the pace of tightening rather than prevent it from extending further.

Meanwhile, protests continued yesterday and have now left at least one protestor dead, while several have been injured. Police have also reported several injuries as they try and contain the violence. Of course, political actors are using this as a propaganda tool, with both sides jumping on the bandwagon to try and build up more support for their respective sides.

On the tax reform front, there is the possibility that President Castillo could get higher taxes on mining companies passed through Congress if the compromise is that other sweeping tax reforms are not imposed. Castillo will want to focus on mining in an effort to raise further revenues to support social spending programmes, especially now in light of the ongoing protests and surge in the cost of living for most Peruvians. Of course, miners will not respond well to higher taxes, especially given how operations at many major facilities have been hampered recently by community protests. Miners will claim that the government is not doing enough to ensure that operations are able to continue safely. Therefore, resentment against higher taxes will likely lead to deferred investment or even a complete halt on new projects. This negative sentiment could well then spread through to other sectors of the economy

Forex: Latam FX bulls bailing as Fed tightening set to accelerate

Brazil: The BRL remained under pressure yesterday as external headwinds continued to blow strong. The BRL was the second worst-performing emerging market currency on Wednesday, losing 1.36% against the USD to end the session at 4.7160, according to Bloomberg data. The sell-off in the BRL came on the back of a stronger USD following the hawkish Fed comments and deterioration in global risk sentiment. While the BRL has come under some selling pressure over the past two sessions, the broader bullish bias in the BRL remains intact, with the BRL still the best performing emerging market currency in 2022 by some way. Looking ahead, while we could see the BRL reverse some of its recent gains as external headwinds blow, the combination of elevated rates and favourable trade dynamics are likely to keep the USD-BRL anchored below the 5.00 mark.

Mexico: The USD-MXN advanced yesterday to challenge the 20.200 mark, moving away from a ten-month low of about 19.700 hit earlier this week, due to prospects of more aggressive Fed rate hikes. Latin American currencies underperformed their emerging-market peers as traders trimmed some of their bullish positions after the region’s strong year-to-date rally. The USD-MXN has retreated in pre-market trade this morning as investors await some key catalysts this week, namely March’s CPI reading and Banxico meeting minutes. A hotter-than-expected inflation reading could see the pair rally off the back of it. The first technical resistance level for the pair remains the 200DMA at 20.4182.

Colombia: The COP extended its retreat with a 0.25% depreciation yesterday, with this move completing a retracement of Monday’s strong advance to sub-3700/$ levels. Yesterday’s move was consistent with broader EM currency weakness, as the USD surged on the back of the Fed’s more aggressive tightening outlook and forced COP bulls to book profits and move to the sidelines. Even the higher-than-expected inflation numbers out of Colombia this week could not support the currency, as they were likely deemed insufficient to change BanRep’s more gradual approach to monetary tightening. Momentum thus remains with the COP bears for now, although some consolidation may begin to arise into the weekend

Chile: The USD-CLP broke out of its trading range of late to close at 800.03, hemmed in by the 200DMA resistance level at 800.712. The move yesterday has pushed the local unit into a month to date loss of 1.75% which is the third worst in the emerging market bucket, only the CEE members CZK and HUF have performed worse. Concerns over the constitution and Boric’s approval rating are causing tactical CLP bulls to bail.

Peru: The PEN continued to weaken yesterday and broke through the 3.7000 level to the USD as a result. The continued slump also came despite the central bank selling $148mn in the FX market yesterday to try and arrest volatility within the market. If we see the selling pressure remain entrenched through the session ahead, it could bring a test of the 50DMA at 3.7607. Yesterday's losses also saw a key Fibo level breached. The 76.4% retrace of the PEN's highs and lows for 2021 was broken to the downside, suggesting that the 61.8% retrace could come into play at 3.7927.

Fixed Income: Inversion trade resurfaces following hawkish Fed minutes

Brazil: The payer interest in the swap market persisted yesterday with rates across the curve trading higher, tracking the depreciation in the BRL. The shorter-dated 2yr rate rose 33bps to 11.99%. Meanwhile, the longer-dated 10yr swap rate climbed 17bps to 11.41%. The stronger than expected FGV IGP-DI inflation print would’ve added to the pressure on swap rates yesterday.

As mentioned in recent commentary, while the central bank has communicated that it will end its rate hiking cycle in May with a final 100bps hike, there is a risk that the BCB has to raise rates further as inflation pressures persist. Although oil prices have pulled back from their recent highs, helping to ease inflation concerns at the margin, the market is still pricing in the risk of an extended tightening cycle. The short end of the DI curve is pricing in just under 40bps of rate hikes post the May meeting. Interest rate hike bets could increase in the coming weeks should the currency extend its reversal or commodity prices remain elevated.

Looking at the session ahead, fixed income traders will shift their focus to the weekly vanilla auction. National Treasury plans to sell Selic-linked LTN bonds maturing in 2022, 2024 and 2025 and inflation-linked NTN-B local currency bonds maturing in 2029 and 2033. As always, the volume of notes will be released at 10:30 am local time. Demand at today’s auction could soften amid the sour mood in global markets.

Mexico: Domestic bond yields rallied yesterday, driving the yield curve higher as investors anticipate accelerated monetary tightening cycles to tackle rising inflation following the hawkish FOMC meeting minutes. Bond market weakness is moderating today, which may support risk appetite, albeit at the margin.

According to a Bloomberg survey, Mexico’s yield curve as reflected in the 10yr vs 2yr is expected to steepen to 44bps by the end of the second quarter. In the past six months, the curve has been trading flat around 0bps with a steepening bias of 153bps. For perspective, Mexico’s 10v2 yield curve is trading below that of its regional peers, other than that of Brazil, which are now trading very closely with one another. The difference in the spread between the two curves represents the difference in the monetary policy stance. Mexico has to catch up to its peer, which has hiked interest rates aggressively since last year.

Mexico’s central bank sold MXN28.5bn of Cetes in an extraordinary auction yesterday, according to official results published on Banxico’s website..

Colombia: While some payer interest has been evident along the swaps curve this week, moves have been relatively contained with early trade today also suggesting consolidation could be on the cards. The market is weighing BanRep’s more cautious approach to monetary tightening against an increasingly hawkish Fed that could force the Colombian central bank’s hand in the months ahead. This is making for some uncertain trade in the market, with consolidation seemingly the base case for now.

Chile: Much has been about the Fed of late and we feel that we need to unpack the latest developments as they do impact meaningfully on the local markets. The prospect of Fed policy tightening continues to challenge long-only mandates, with many asset prices under pressure since the FOMC minutes were released overnight. The key take-home was that the Fed is considering increasing rates by as much as 50bp increments, while the rate of quantitative tightening will be almost double that of the prior cycle. There is a proposed commencement date of May 2022.

This is consistent with the guidance of recent months and suggests that the US central bank considers inflation a major risk if expedited rate of tightening isn’t implemented. The statement was a little less hawkish than some had feared.

All this suggests that the Fed believes that US demand-side inflation risk needs to be taken care of and that the level of policy tightening should be aggressive to achieve that. There is a popular narrative among academics arguing that previous aggressive inflation episodes took policymakers a long time to deal with because they took too long to respond appropriately.

The local swap curve has certainly taken this to heart and the dis-inversion pressures have dissipated and we are back on the inversion trade again. The 2v10 is currently quoted at -116 bpts after touching highs of -97.5 bpts on Friday. Granted we are nowhere near the lows of -204.5 bpts which we saw mid-march. Perhaps the move extends further as the market tests the BCCH resolve of a less aggressive monetary policy outlook given the slowing economy.

Peru: Selling of local currency government bonds continued yesterday, with yields rising across the curve which steepened out. Bonds were pressured by rising yields in the US as well as a result of the social unrest taking place in the country at the moment. With the recent rise in yields, the 2031 tenor is on track to reach 7.000% while at the front-end, the 2023 tenor could touch 5.00% in the sessions ahead. For the session ahead, focus will remain on external developments and the ongoing protests, with the BCRP rate announcement only scheduled for after the local market closes.