Morning Note /

Latam Daily: Regional growth outlook weakens on political shifts

  • Talking Points: Colombia CPI accelerates, Chile pushes forward with Constitution reform

  • Forex: Hawkish Fed to put Latam FX on the backfoot for now

  • Fixed Income: Yields rise on monetary conditions set to tighten globally

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Daron Hendricks
Danny Greeff
Kieran Siney
ETM Analytics
6 January 2022
Published byETM Analytics

Talking Points: Colombia CPI accelerates, Chile pushes forward with Constitution reform

Brazil: Looking at the session ahead, Brazil’s calendar is headlined by the November industrial production report. Consensus expectations suggest that industrial production expanded marginally in November, with economists pencilling in growth of 0.1% m/m from a contraction of -0.6% in the previous month. On an annual basis, activity in the industrial sector is expected to contract given the sharp recovery in the sector last year, driven by low interest rates, a weak currency and a shift in consumption to goods rather than services amid all the social distancing measures that were in place. We see the risk for a downside surprise in the print today. If this materializes, it will be the latest economic data to suggest that Brazil’s economy is struggling

Taking a look at the outlook for the regional economy, it appears that 2022 will not follow 2021 in terms of the impressive economic growth rates seen throughout many of the countries in Latam. The surge in COVID cases poses some risks even though it is well known now that the omicron variant is less deadly than previous variants. Inflation also remains a major factor to keep an eye on, with high levels of price growth across the region diminishing the purchasing power of consumers while also leading to tighter monetary policy conditions.

The political situation is also as fragile as ever, with expectations that we should see a notable shift to the left. This has already been seen in Peru as well as Chile, while elections in Colombia and Brazil this year are very likely to see more left-leaning candidates win. More populist policies along with high levels of uncertainty will certainly dent the outlook for investment and lower business confidence levels. Peru was a prime example of how capital flight and asset deprecation can occur following elections. A warning to the likes of Colombia and Brazil

Mexico: Citibanamex’s analysts lowered 2021’s inflation expectations to 7.45% from 7.66% forecasted at the end of last year while maintaining 2022’s headline figure at 4.16%. Investors will have December's CPI figures to look forward to tomorrow. Meanwhile, the survey also cut Mexico’s 2021 GDP estimate to 5.5% from 5.6% previously and kept this year’s growth forecast unchanged at 2.8%. The most notable development in the recent survey was the economists view on monetary policy. The panel lowered its rate hike expectations to 25bps vs 50bps in the upcoming February meeting. Should inflation begin to moderate after December’s aggressive 50bps increase, Banxico will likely have a bit more policy flexibility to hike rates by 25bps. Investors will be scouring the central bank’s latest meeting minutes, scheduled for release today, for a clear outlook for monetary policy. We can expect the minutes to show the less-dovish stance adopted by the US Federal Reserve in December, contributing to the 50bps rate hike, together with the high and resilient inflationary pressures.

Colombia: CPI data released yesterday showed Colombia's inflation rose by more than expected in December, supporting concerns about the price-growth outlook. CPI growth accelerated from 5.26% y/y to a five-year high of 5.62% y/y, with this well above the 5.41% y/y print pencilled in as the consensus forecast on Bloomberg. Notably, core inflation accelerated from 3.37% y/y to a 3.44% y/y, with growing evidence to suggest that shocks keeping non-core inflation above target are increasingly spilling over to prices of other goods and services and contaminating expectations. This print added to the argument in favour of more BanRep rate hikes in the months ahead, even as COVID-19 concerns remain heightened across the globe.

Chile: The Finance Committee of the Chamber of Deputies approved yesterday a bill that reduces or eliminates tax exemptions in order to help finance the new guaranteed pension framework. Furthermore, a wealth tax was created which was approved by 7 to 6 votes. This will all now go to the Lower House Floor to be ratified there. The government has, however, announced that it would go to the Constitutional Court to fight this article if it is approved, according to Biobio.

Meanwhile, the Constitutional Assembly has elected Maria Elisa Quinteros as its new president. Quinteros was chosen after nine rounds of voting which spanned almost 15 hours. She will now look to guide the assembly as it pushed ahead to conclude work on the new constitution before the 5 July deadline. The changes may pave the way for radical economic reforms and undo a lot of the business-friendly policies that Chile has used to great effect in recent years. There will, however, be a lot of political wrangling given that each new article will require a two-thirds majority to approve. Investors, therefore, may be in for a fairly uncertain time ahead.

Peru: Focus today will, of course, be centered on the local rate decision, with consensus expectations penciling in another 50bp rate increase to take the Reference Rate up to 3.00%. Key will be the central bank's forward guidance to see if it maintains its view that further policy normalization will be gradual. This outlook could change slightly given that recent inflation figures were higher than expected, while the Fed has shifted to an even more hawkish stance. More details can be found in the interest rate section below.

Meanwhile, Peru has declared the capital of Lima as a high-risk area following a surge of Omicron cases. A new curfew has thus been imposed, coming into effect from 11pm to 4am. The Health Ministry has, however, noted that mortality rates remain low despite the surge in new infections, which suggests that more stringent restrictions may not follow. The economic impact should be minimal.

Forex: Hawkish Fed to put Latam FX on the backfoot for now

Brazil: The BRL extended its losing streak on Wednesday even after President Jair Bolsonaro was discharged from a hospital without needing surgery for an intestinal obstruction. The BRL closed the session 0.54% weaker against the USD at 5.7161 as mounting fiscal risks and as concerns over the Covid pandemic intensified after Brazil recorded its biggest one-day increase in cases since October.

Some hawkish Fed minutes have resulted in the USD unwinding all of yesterday's losses. However, it may be significant that the USD did not surge any more than it did and continues to trade in what has become a well-worn range for more than a month now. It may be that the market is still looking to see how the Omicron variant unfolds before adopting any clear cut direction, while focus ahead of the weekend will fall on the remaining two labour market data releases for further insight. Although there is a slight bullish undertone to the USD, it remains mostly rangebound.

Mexico: The USD’s rally stalled on Wednesday in the build-up to the release of the FOMC monetary policy meeting minutes and US economic data, offering Latin American currencies the chance to trim some of their recent losses, particularly those linked to commodities such as oil and metals. The MXN advanced to 20.343/USD but could not hold onto its earlier gains, closing just above the 100DMA pivot level at 20.568/USD. Ahead of the NorAm session, the local currency has slid more than 1.2% at the time of writing, the most in the emerging market currency basket, as the hawkish Fed provides support for the USD. Traders will continue to digest the FOMC minutes but will also need to stomach Banxico’s meeting minutes. The MXN will likely trade on the back foot for the remainder of the week, should risk aversion intensify. The 50DMA support at 20.8533/USD will be a key level to watch.

Colombia: The COP led regional currency gains with a 1.40% advance against a retreating USD through yesterday's trading session. The local unit found support ahead of the Fed meeting minutes' release, while rising commodity prices also contributed. These gains might not be sustained into today's open, however, with the USD regaining its shine overnight after the Fed minutes reaffirmed the central bank's intentions to tighten monetary conditions aggressively in the coming months. That being said, the COP may trade with added resilience to this greenback strength, given that Colombian CPI data released after yesterday's close pointed to more aggressive rate hikes in Colombia too.

Chile: The CLP rallied yesterday, breaking through the 840 per dollar mark while testing the 50DMA at 831.56. Given current market conditions, we should see these gains reversed in the session ahead, with the 50DMA likely to remain an attractive level for traders to buy USDs. Traders are, however, still expecting some volatility over the coming months, with the 1-month implied vol tenor on the USD-CLP still trading well above 17.000%. This volatility isn’t expected to die down either, with the 3-month tenor at over 16.000% currently.

Peru: The USD-PEN tested a break below the 200DMA support yesterday, but reversed direction after the release of the FOMC minutes. The more hawkish outlook for Fed policy will dent the outlook for the PEN and should see profit-taking materialize if we see any further gains for the local unit over the near term.

Fixed Income: Yields rise on monetary conditions set to tighten globally

Brazil: Given its influence on the global fixed income market, it is worth zooming in on US Treasuries this morning. The hawkish FOMC meeting minutes published last night saw US Treasury yields rise further as the market prices for a more aggressive policy tightening by the Federal Reserve this year as inflation pressures persist.

The minutes from the December Fed meeting confirmed that policymakers discussed hiking interest rates earlier and at a potentially faster pace than previously communicated, given the strengthening economy and higher inflation. The details of the meeting also showed that some officials now favour qualitative tightening soon after the first rate hikes, with all members unanimous in their view that these hikes will come this year.

Yields on the 2yr and 10yr Treasuries rose above 0.83% and 1.70%, respectively, while the S&P had its worst session since 26 November, sliding by around 1.50%. Market pricing for a rate hike as early as March has now reached 80%. The sustained rise in US Treasury yields has come as a headwind for emerging and frontier market bonds. Going forward, given our expectations for inflation to remain elevated in the first half of the year, we expect the broader bearish bias in global bonds to persist. .

Mexico: Mexico’s short-dated borrowing costs rose on Wednesday, following the US Treasury sell-off that is griping financial markets as the US Federal Reserve is set to raise interest rates faster than currently anticipated to contain inflation. The MXN yield curve shifted higher, as a result, with the 1yr and 10yr bond yields rising by 9bps and 3bps to 7.05% and 7.82%, respectively. Looking to the session ahead, the US 10yr bond yield has climbed to 1.74%, just shy of the 2021 high of 1.77%. The benchmark US bond yield has spiked by 22bps this week and is set for the steepest increase since June 2020. The jump will continue to spark a sell-off in bonds and equities.

Colombia: The Colombian bond market's selloff continued on Wednesday, with yields across the curve tracking their UST counterparts higher through the session. Moves were more pronounced at the long-end of the curve, leading to a sharp steepening thereof. The short-end may play catchup today, however, since CPI data showed inflation was higher than expected at the end of last year. Simultaneously, Colombian bonds will also continue to reflect political risk ahead of this year's upcoming elections, as well as broader market concerns over the prospect of an accelerated tightening of financing conditions abroad.

Chile: Chilean bonds came under some pressure yesterday, unsurprisingly given the local developments as well as the hawkish FOMC minutes that were released. With global monetary conditions set to tighten, and political and economic uncertainty in Chile likely to remain elevated, the outlook for bonds going forward looks fairly bleak. We could see yields rise further in the near term as a result, which will make government bonds look attractive to those betting that the government may tone down its left-leaning rhetoric, or that the Constitutional assembly will struggle to significantly change the constitution..

Peru: Yields surged across the board yesterday when looking at the local yield curve. Unsurprising given the hawkish FOMC minutes. The curve flattened out with front-end yields rising almost 15bp on the session as investors price in tighter US monetary policy and expectations that this could lead to greater rate hikes on the local front. This makes for an interesting session ahead, although we could see some consolidation now given that the BCRP rate announcement will take place after market hours.