Morning Note /

Latam Daily: Regional political woes come as external sentiment sours

  • Talking Points: Peru ends lockdown but protests set to continue, Chileans likely to reject constitution rewrite

  • Forex: Latam FX under pressure on tightening global financial conditions

  • Fixed Income: Bonds yields set to rise further, curves to keep flattening

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

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

Talking Points: Peru ends lockdown but protests set to continue, Chileans likely to reject constitution rewrite

Brazil: Traders will take direction from external developments in the session ahead as markets continue to digest the developments in Russia, growing concerns over China and the hawkish shift in rhetoric from the Fed. That said, we have some second-tier inflation scheduled for release today, which given the sensitivity of financial markets to monetary policy dynamics, could result in some price action. While the BCB has communicated that it is likely to end its rate hiking cycle with a 100bps rate hike in May, the market is still pricing in the risk of more rate hikes in the subsequent meetings as inflation pressures remain robust.

Domestic headlines remain centred on Petrobras after President Bolsonaro’s choices for chief executive officer and chairman have abruptly pulled out in what has turned into a public relations fiasco. The political meddling in the state controlled oil producer highlights Petrobras’s political importance as domestic fuel prices surge ahead of the October election. With Petrobras now a focal point for both Bolsonaro and Lula, the two front runners for the October election, we expect political interference in the oil producer to remain a theme in the months ahead as politicians look to lower fuel prices to boost their supportership.

Mexico: According to data published by Banamex yesterday, Mexico’s analysts revised their inflation forecasts for this year higher to 6% from 5.70% in the prior survey. Meanwhile, the inflation prediction for 2023 has remained unchanged at 4%. In contrast, economic growth projections for 2022 have been lowered from 2% to 1.9%. Economists believe the central bank will continue to normalize policy, with the next rate hike scheduled for May, with a 50bps increase. Banxico is under significant pressure to contain inflationary pressures while also managing sluggish economic growth. The Federal Reserve's hawkish tilt adds to the pressure to raise interest rates further.

Yesterday's local news headlines focused on a court decision regarding Mexico's President Lopez Obrador's nationalist power reform. However, after two hours of deliberation, Mexico's Supreme Court decided to postpone its ruling until Thursday. The reform, which is part of Obrador's effort to reclaim state control of the energy sector, was enacted last year but has been suspended by judges from specialized competition courts. Its fate now rests with the Supreme Court. If four additional lawmakers agree with Laynez Potisek and Gonzalez Alcantara's key points yesterday that the crux of the law was unconstitutional in favoring the state utility over clean energy, it will be a setback for Obrador's principal policy goal.

Colombia: CPI numbers released yesterday showed that inflation exceeded expectations in March, rising from 8.01% y/y to a 2016-high of 8.53%. Food inflation soared to its highest on record, with these price pressures only set to accelerate in the coming weeks due to the ongoing Russia-Ukraine war. Meanwhile, regulated inflation showed signs of moderating, owing to government efforts to limit the impact of high global oil prices. On the whole, rising headline inflation in Colombia will add pressure on the central bank to do more to rein in surging prices, especially given concerns over the impact of prevailing inflation on inflation expectations. However, the central bank finds itself between a rock and a hard place, as it will also need to weigh in the impact the war will have on economic activity and the labour market.

Chile: A survey published this week showed that people are more than likely willing to reject rather than accept the new constitution for the first time, which is not surprising given that many of the proposals have been radical to say the least. Certain proposals regarding the environment and property rights have raised eyebrows as they risk making Chile a non-starter in terms of investment going forward. Radical idea’s also welcome contention and criticism given the need for a pragmatic approach to getting this over the line by the July deadline.

It is against this backdrop that the President made comments to reporters while on his official visit to Argentina. Bloomberg reported - Recent poll data showing the population’s growing mistrust in the Constitutional Convention are a “wake-up call,” Boric told reporters on Tuesday while on official visit in Argentina. He added that he knows people who initially backed a new charter in the 2020 referendum and now have doubts about the process. “We are worried,” Boric told reporters. “We want to bring people together, we want to convince. We all have a role to play and, of course we’ll do it.”.

Peru: In an effort to appease protestors, President Castillo has lifted the lockdown imposed on Lima after lawmakers pressured him during a meeting yesterday. Lawmakers contended that the curfew was against fundamental human rights. The reaction to the protests and the recent impeachment attempt against Castillo have seen many institutions predict that the president will not survive his full term, either by being impeached or resigning. Moody's, however, noted that even if this materializes, Peru's current orthodox policies will continue to underpin the country's creditworthiness, suggesting that the risk of a downgrade from the agency is still relatively small.

The protests, however, are likely to continue and could become more violent after a government official yesterday suggested that the police will be allowed to use force if necessary to keep things under control. Therefore, political and economic risks remain high, and we still wait to see what the government and Congress will agree on in terms of measures to combat inflation and return the situation to normal.

Forex: Latam FX under pressure on tightening global financial conditions

Brazil: Emerging market FX was a sea of red on Tuesday as global headwinds intensified on concerns surrounding Russia and hawkish comments from the Fed. The combination of risk aversion and a stronger dollar saw the BRL snap a multi-day winning streak, closing the session 1.28% weaker at 4.6517, according to Bloomberg data. Global risk sentiment soured amid concerns of another round of harsh sanctions from the West on Russia. The European Union proposed new sanctions against Russia, including a ban on coal imports. The USD is also preparing to ramp up its sanctions against Russia following alleged war crimes.

Meanwhile, the USD surged higher after Fed member Brainard emphasized the rapid shrinking of the Fed's balance sheet, adding that it did not have to take place as slowly as it did the previous time. The hawkish shift took the market by surprise, especially as the rapid rate of tightening currently being priced into the market has already resulted in the US yield curve inverting and raising fears of a material slowdown in the quarters ahead. Then later in the session, San Francisco Fed President Daly passed comments that inflation running at a 40yr high was as "harmful as not having a job," referring to the impact that high inflation has on the disposable income of households. She emphasized that the Fed would not allow this phase of high inflation to persist and that the Fed was committed to reducing inflation to pre-covid levels.

This is hawkish talk by the Fed, but it is the kind of guidance central banks deploy to prompt the market to do some of the heavy lifting in tightening monetary conditions in the hope that they won't have to drive benchmark interest rates as high as they otherwise might've done. It is a case of talking tough to avoid having to act quite as tough. Financial markets have chosen to take the guidance seriously, and stock markets have sold off, and that has spilt over into risk markets and, to some extent, into commodity prices.

Mexico: The tide for the USD-MXN has turned. Yesterday the pair snapped a five-day losing streak after coming under pressure from broad USD strength, underpinned by hawkish remarks by Federal Reserve policymakers. The pair closed at the 20.00 handle, a key resistance level, which the pair has scaled above this morning to 20.0140 at the time of writing. The strong upside move comes off a 10-month low of 19.7274 on Monday, which suggests there is room for the USD-MXN bulls to run. Meanwhile, the US dollar index (DXY) is heading towards the psychological figure of 100.00, a near two-year high, tracing the US Treasury yields and souring risk appetite. From here, the USD-MXN risks rallying towards the first technical resistance level, the 200DMA at 20.4168.

Colombia: After its stellar start to the week, the COP retreated yesterday with a 0.95% depreciation. This was consistent with regional currency moves through the session, and was primarily a function of USD strength after Fed Governor Brainard's hawkish rhetoric. The USD-COP remains anchored below the 3750 mark for now, and will likely find short-term directional cues from developments in Ukraine and the Fed meeting minutes that are scheduled for release today.

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 shed ground against a broadly stronger dollar yesterday, finishing at 786.74 which is within the current range. All eyes are on the US FOMC minutes later this evening.

Peru: The PEN had its worst session in weeks yesterday and underperformed its Latam peers as social unrest mounted. The currency lost almost 1.50% on the day and closed the session at around 3.7000 to the USD. It will likely remain under pressure over the coming sessions, bringing the 50DMA at 3.763 into view. We will also have the BCRP rate announcement tomorrow to contend with, which adds further uncertainty and could make investors wary of buying any dips just yet. Technically, the stochastic has issued a crossover buy signal on the USD-PEN pair, just as it neared oversold, suggesting more PEN weakness could be on the cards from a technical standpoint.

Fixed Income: Bonds yields set to rise further, curves to keep flattening

Brazil: The sell-off in global bonds deepened on Wednesday as investors dumped bonds following a wave of hawkish comments from the Fed. The prospect of more aggressive tightening from the Fed pushed yields across the US Treasury curve higher as traders priced in the risk of steeper rate hikes. The bearish bias came after Fed member Brainard said that the central bank would continue tightening policy periodically, adding that inflation is concerningly high and that getting it down is the Fed’s top task.

Brainard said that the Fed aims to shrink its balance sheet by as soon as May while noting that the combination of rate hikes and the balance sheet shrinking should see monetary policy return to a neutral level by the end of this year. Brainard said that the Fed is watching the yield curve closely for signals of downside risk. The US Treasury curve has triggered a recession warning with the 10v2 spread, historically an accurate predictor of recessions, briefly inverting in recent days.

Fears of more aggressive tightening from the Fed saw the benchmark 10yr US Treasury yield rise 15bps to 2.55% on Wednesday, the largest upside move since the onset of the Covid pandemic in March 2020. The shorter-dated 2yr yield meanwhile rose 9bps to 2.52% on Wednesday, its highest level in more than three years. The bearish bias was not contained to US Treasuries, with bonds across the globe suffering notable losses yesterday. The JP Morgan EMBI Global Total Return Index, which we use as a proxy for the performance of emerging market bonds, closed the session lower on Wednesday as investors scaled up rate hike expectations in the face of soaring global inflation and the hawkish commentary from the Fed. Brazilian bond yields also traded higher, climbing 6-25bps.

With the situation in Ukraine worsening, amplifying global supply chain pressures, we expect the broader bear flattening bias in the global bond market to remain intact, especially as the Fed tightening narrative is moved up in time and magnitude. It is looking likely that the Fed’s quantitative tightening will begin as soon as May, which will also reduce dollar liquidity in the global financial system, a factor that has up until now been supportive of riskier assets.

Mexico: Local bonds fell in line with the global bond sell-off as investors anticipate accelerated monetary tightening cycles to tackle rising inflation after US Fed Governor Lael Brainard indicated support for higher interest rates overnight. Specifically, MXN bond yields rose between 6bps – 10bps along the sovereign bond curve. This month, so far, has seen debt markets come under considerable selling pressure, with the US Treasury 10yr bond yield surging above 2.63%, its highest level since March 2019. Mexico’s 10yr bond yield, meanwhile, is trading just below the 8.44% mark, its highest level since January 2019. With the bond rout intensifying and the MXN on the defensive, the MXN 10yr bond yield risks rising above 9%, a level last seen during the Global Financial Crisis.

Colombia: While the Colombian bond market has cheered a relatively less-hawkish-than-expected BanRep outlook and poll results showing leftist Senator Gustavo Petro no longer enjoys a clear lead in the upcoming presidential elections, US Treasury yields have surged to 2019 highs on the back of an increasingly hawkish Fed outlook. The net result has been a marked compression of the 10v10 yield spread between Colombian and US bonds to 673bps. This is significantly lower than the 785bp spread just a month ago, and may begin to render Colombian bonds less attractive to foreign investors in due time.

Chile: The great unwind of the curve inversion trade seems to have stalled somewhat as the 2v10 spread closed at -110.5 bpts yesterday after closing at -97.5 bpts on the 1st April. The market has experienced significant volatility and repricing following the less hawkish stance from the new Central Bank administration. Subsequently, the data released has supported the banks view as it shows a steadily slowing economy. The next major release which will influence the rates market comes in the form of CPI due this Friday, market expectations has the March print accelerating again with 1.1% penciled in month on month, versus 0.3% in Feb..

Peru: Local government bonds remained pressured yesterday by rising political unrest and concerns over the economic impact. Yields were up by as much as 13bpon the day with the front-end underperforming. Dollar bonds also suffered on the session as investors grow increasingly concerned over the political risk facing the country. Generally, USD bonds may outperform during times like these, but tightening global financial conditions and risk aversion globally mean that the selling of Peruvian assets will be fairly broad-based until we see conditions start to normalize. We could, therefore, see the rotation out of Peru continue over the near term.