Macro Analysis /

Policy normalization in Latam continues, Peru and Mexico hike rates

  • Talking Points: Policymakers in Mexico and Peru go ahead with rate hikes

  • Forex: BRL best performing EM currency on Thursday, closes session at strongest level in a month

  • Fixed Income: Inversion in Brazil’s bond curve triggers stagflation fears

Kieran Siney
Kieran Siney

Head of African Markets

Daron Hendricks
Danny Greeff
ETM Analytics
12 November 2021
Published byETM Analytics

Talking Points: Policymakers in Mexico and Peru go ahead with rate hikes  

Brazil: Stagflation fears intensified on Thursday following the release of more downbeat data. Retail sales decreased by -1.3% m/m in September, below the consensus forecast for a less pronounced drop of -0.6%. It is worth pointing out that the August reading was revised down to -4.3% from -3.1% previously. On an annual basis, the pace of contraction in the retail sector worsened to -5.5% in September from -4.1% in August. A breakdown of the data revealed that 6 out of the 8 categories recorded declines. While the government is likely to push through President Bolsonaro’s new social program, which will provide cash handouts of BRL 400 to poor families, which should provide a boost to sales, interest rates are rising sharply, which is dampening consumer sentiment. On balance, rising inflation, increased interest rates and tighter financial conditions suggest that the recovery in the retail sector and the economy is likely to remain fragile in the months ahead.

Mexico: By majority vote, 4-1, Banxico raised its interest rates by 25bps yesterday for the fourth consecutive policy meeting, taking its benchmark rate to 5%, indicating its commitment to price stability and strengthening its monetary prudence, with the door remaining open for more rate hikes to come. The board agreed that global and domestic inflationary pressures continue to affect headline and core inflation, so expectations regarding headline and core inflation for 2021 and 2022 rose again, while long-term ones remain stable at levels above the goal. Members expect headline and core inflation to decline from Q2 of 2022 and converge to the target towards the end of Q3 of 2023. The global inflation theme is triggering monetary policy tightening across most jurisdictions, and Mexico's rate hike highlights how EMs will not be spared the need to tighten policy, not just to combat inflation but also to restore real interest rates as DMs recover. Notably, the hike, to 5%, still leaves Mexico with a negative real interest rate.

Colombia: There were some noteworthy local statistical releases for the market to digest yesterday. Retail sales growth dropped from 32.0% y/y to 15.3% y/y in September, reflecting statistical base effects, with the positive growth rate consistent with economic activity still picking up amid fewer restrictions, expansionary economic policy, and improving sentiment. Painting a similar picture, industrial production growth also declined from 15.5% y/y to 13.7% y/y. More insights into the net effect of fading base effects and improving economic conditions will likely also be reflected in the economic activity and GDP stats that are scheduled for release after the long weekend, with these prints set to hold plenty of market-moving potential.

Chile: The week has generally been positive on a number of fronts for the local markets as sanity prevailed in terms of the 4th pension fund withdrawal bill which failed to pass and news that the government had reached consensus with the opposition for the 2022 budget, which has now been dispatched to the Chamber of Deputies where the text of the budget will be analysed again. The session between the various parties regarding the budget was said to be a marathon one, with discussions taking place for 16 hours. The deadline for the initiative to be passed into law expires on Tuesday the 23th November 2021.

Peru: Following 125bps worth of rate hikes since August, the BCRP raised the benchmark Reference Rate by another 50bps to 2.00% at its November policy meeting yesterday. Forward guidance accompanying the decision pointed to a moderation in monetary tightening in the months ahead, with the central bank likely to skip some meetings or end its rate-hike cycle early in 2022. However, policy space to move ahead with those plans will depend on price pressures waning in line with the central bank's expectations, with, inflation expected to decline back into the BCRP's 2.0% +/- 1 percentage point target range by H2 2022. This follows as disinflation forces from a negative output gap and waning shocks from accumulated currency weakness and high commodity prices are set to come into play, although there are significant risks to this outlook. Accordingly, the central bank will remain highly data-dependent in its assessment, meaning incoming economic stats will continue to hold plenty of market-moving potential.

Forex: BRL best performing EM currency on Thursday, closes session at strongest level in a month

Brazil: Notwithstanding the sustained rally in the USD, the BRL extended its recovery yesterday. The BRL was the best performing emerging market currency on the day, gaining 1.72% to end the session at 5.4046 against the USD, its strongest level in over a month. Underpinning the bullish bias in the BRL yesterday were the comments from Economy Minister Guedes, which helped settle some of the uncertainty about how the government will finance its new social welfare program. Adding to the tailwinds for the BRL yesterday was higher metal prices, driven by some relief over China Evergrande. That said, Iron ore prices are on track for a fifth weekly fall, even following yesterday’s relief rally as worries about demand given China’s soft patch outweighed the news that Beijing would be easing financing restrictions in an attempt to bolster the property sector.

Mexico: The USD-MXN closed out Thursday at 20.6367, down 0.1% after unwinding most of its losses as Banxico's gradual cycle of tightening failed to inspire the MXN bulls, given the backdrop of poor industrial activity. Fortunately for the USD-MXN, it means it will continue to build on its rally this month, potentially into the end of the year, as the underlying bias remains firmly to the upside. The first test for the bulls, will be this month’s high at 21.000. Heading into the weekend, the pair is leading EM currency FX pairs higher, up 0.8% and will be looking for a close above 20.700.

Colombia: The COP consolidated Wednesday's losses with a 0.10% gain yesterday, as it tracked regional currencies higher amid fading risk aversion through the session. Note that oil prices also rose slightly on Thursday, providing the COP with added support. Heading into the long weekend, the focus is on the USD and whether or not its recent rise has reached a ceiling, with markets generally taking on a more consolidatory tilt ahead of the open.

Chile: The peso is in a phase of consolidation following the sharp losses seen on the USD-CLP earlier in the week. For now the pair seems to be content on pivoting around the 795 level. FX markets are trading mixed in the EU session as tactical players adjust risk ahead of the US data due this morning. Expect a measured open.

Peru: After climbing to a 1-month high on Wednesday, the USD-PEN traded lower yesterday with the local currency gaining on the back of higher metals prices, a main source of foreign currency for Peru, and expectations for the central bank to deliver a bold rate hike. While the PEN strengthened yesterday, the broader narrative of the BCRP’s policy statement was less hawkish than some may have expected. This comes against the backdrop of a sustained rally in the USD, both of which point to a challenging session ahead for the local currency. 

Fixed Income: Inversion in Brazil’s bond curve triggers stagflation fears

Brazil: The swap curve shows that the market continues to price in significant rate hike risk over the next 12 months. That said, it is worth noting that swap rates on the contract due in January 2023, which we use as a gauge for interest rates for the end of next year, fell sharply yesterday on the back of mounting economic concerns, with fears of stagflation becoming more apparent as time moves on.

While longer-dated swap rates traded higher yesterday, the 10v2 swap spread remains inverted. Historically, an inverted curve has been a reliable indicator of an impending recession. As such, investors will continue to pay close attention to the shape of the swap and bond curves in the weeks ahead. The last time the 10v2 spread inverted was in 2016, when the economy last suffered a recession preceding 2020. Economists partly blamed the 2016 recession on chronically high-interest rates. The recent spike in interest rates and expectations for higher rates in the months ahead has sparked fears that we could see a repeat of 2016, especially if political and fiscal uncertainty rises further.

Mexico: Mexico’s central bank took the safer option yesterday by delivering a 25bps hike that extends the previous cycle to continue supporting the economic recovery. The market was squared off for a more considerable hike, and so the more dovish leaning central bank led to swap rates being received across the curve yesterday. Specifically, short-term swaps fell between 10bps – 20bps yesterday, while those on the belly and long-end reported a 5bps move lower. Swaps had been pricing in slightly less than 25bps in one month’s time and 75bps in three months. Given that there’s one meeting left for the year, it doesn’t leave much room for receiving short-term rates. Looking to next year, investors are pricing 165bps worth of rate hikes.

Colombia: The Colombian bond market's bull-steepening bias of late came to an end yesterday, with selling pressure seen across the curve as the market continued to cut risk exposure in the wake of Wednesday's CPI scare. Notwithstanding yesterday's reversal, the yield curve looks set to end the week notably steeper and lower due to the strong demand for short-end tenors seen at the start of the week. This follows as the market has scaled down bets for aggressive monetary tightening in Colombia recently after local CPI data came out softer than expected. On the whole, uncertainty remains the order of the day, with economic data releases holding plenty of market-moving potential in this context as investors try to position for the pace of the Colombian rate trajectory going forward.  

Chile: The risks associated with Chilean bonds has moderated extensively of late and one measure that depicts this is the spread of the local 10yr bond over the world benchmark US 10yr Treasury. The spread topped out at 528 bpts on the 14th October and has since compressed to 451 bpts currently. Granted we are still trading way higher than the annual mean of 265 bpts. This may well be justified given recalibration of growth and inflation expectations as well as the additional spending that the government of the future is going to have to accept.

Peru: The flattening bias in Peru’s bond curve has come to a halt this week, with the 10v2 spread rising from its lows seen on Monday. Specifically, after falling to a fresh year-to-date low of 206bps on Monday, the 10v2 spread has widened marginally over the past few sessions to 213bps, according to Bloomberg data. This came on the back of expectations for the BCRP to stick to its forward guidance amid signs that some of the external price pressures have abated, albeit ever so slightly. That said, while the BCRP said in its policy statement released overnight that inflation is expected to decelerate to back within its inflation target range in the second half of next year, we still assess inflation risks to be skewed to the topside. Therefore, the broader flattening bias in the curve is likely to remain entrenched.