brazil to outperform peers in new external environment · brazil to outperform peers in new...

Brazil to outperform peers in new external

environment

Latam Fixed Income Strategy Monthly January 27, 2017

Please refer to page 23 of this report for important disclosures, analyst certifications and additional information. Itaú BBA does and seeks to do business with Companies covered in this research report. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the sole factor in making their investment decision.

Itaú Corretora de Valores S.A. is the securities arm of Itaú Unibanco Group. Itaú BBA is a registered mark used by Itaú Corretora de Valores S.A.

Highlights

Global GDP growth is set to accelerate to 3.6% this year from 3.1%

in 2016 and there are upside risks. Global inflation is also on the

rise, driven by better commodity prices. With better economic

outlook, interest rates are set to rise in developed countries.

The main risks at the moment are political shifts in the U.S., Brexit

and elections in Europe. China also poses risks, but we see a stable

growth environment in 1Q17.

Amid this external environment and less gradual monetary policy

normalization in the U.S., we think Brazilian fixed income markets

have a comparative advantage vis-à-vis large EMs.

The strong adjustment of Brazilian external accounts that took place

in 2016 and the ongoing fiscal reforms debate contrast with

idiosyncratic uncertainties weighing on Mexico, Turkey and South

Africa.

Such improvement in Brazilian fundamentals suggests the expected

changes in external liquidity will have a diminished impact over the

BRL’s volatility relative to other high-yielders.

STRATEGY TEAM Ciro Matuo, CNPI [email protected]

Eduardo Marza [email protected]

Contents

1) Currencies p.

- Brazilian Real 4

- Mexican Peso 5

- Chilean Peso 6

- Colombian Peso 6

2) Rates

- Brazil Rates 7

- Non Brazil Rates 10

3) Appendix 15

Latam Fixed Income Strategy Monthly – January 27, 2017

1) Currencies For a thorough macroeconomic discussion, see LatAm Macro Monthly – Stronger global growth, not in LatAm (yet), January 20

Overview

The widespread asset rotation that accompanied the U.S. elections weighed on LatAm assets – particularly on

Brazilian CDS spreads and local rates. Data from the Institute of International Finance reveals that outflows from

emerging markets in November were almost as high as those seen during the “Taper tantrum”. We’ll argue below

that Brazil is poised to outperform large EM peers and we see room for further improvement in real rates (but not in

nominals, for the time being).

Over the past month, commodity prices have continued to rise, driven by strong global economic indicators and

preliminary signs that Opec members are complying with the deal to cut production. Given that China’s economy is

set to remain positive in 1Q17, and the delay in the reaction of U.S. shale-oil producers, short-term prices may

continue to be driven by a tight market. Looking ahead, we expect metal and energy prices to decline throughout

2017, given our projected slowdown in China in 2H17 (particularly in metal-intensive sectors) and stronger oil supply.

We maintain our YE17 Brent forecast of USD 54/bbl, a level that would allow for an additional response by U.S.

shale-oil producers to partly offset Opec’s agreement. For more, see our Commodities Monthly Review – Enjoy the

party, for now, January 18.

-40

-30

-20

-10

0

10

20

30

40

50

60

Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16

EM outflows after the U.S. elections

Source: IIF, Itaú

EM portfolio flows tracker (total inflows)

USD billions

Taper tantrum U.S. elections 10

15

20

25

30

35

Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16

Volatility measures

Source: Bloomberg, Itaú

VXEEMVIX

https://www.itau.com.br/itaubba-en/economic-analysis/publications/latam-macro-monthly/stronger-global-growth-not-in-latam-yet

https://www.itau.com.br/itaubba-en/economic-analysis/publications/commodities-monthly-report/enjoy-the-party-for-now

https://www.itau.com.br/itaubba-en/economic-analysis/publications/commodities-monthly-report/enjoy-the-party-for-now


The COP (+3%) benefited heavily from (still tentative) signs that oil-exporters (Opec members and otherwise) are

complying with the agreement. Amid the expected changes of external financial conditions, the currencies of

countries with low current-account deficits (Brazil and Chile) outperformed LatAm peers over the past 30 days: both

the BRL and CLP strengthened 3%. In fact, option prices suggest that the BRL is less vulnerable to the change in

external financing conditions relative to other large EM markets (Mexico, South Africa, Turkey and Russia). After

detaching from peers during 2H15 and 1H16, the market expectation for BRL’s volatility embedded into at-the-money

options (6-month term) decreased steadily over the second half of 2016 and currently lies below the average of

comparable EM countries. We think market sentiment towards Brazilian risk will improve further relative to peers in

coming months. This is so because idiosyncratic uncertainties are likely to increase volatility of the MXN, the TRY

and the ZAR, whereas the fiscal reform effort in Brazil and the strong adjustment in the external accounts that took

place in 2016 will likely keep at bay tail-risk concerns over the BRL.

Our FX-models show that the normalization of Brazilian CDS had a positive impact over the BRL (+3%) over the last

30 days. For the CLP, commodity prices were on the driver’s wheel (+2%), whereas BCCh cut and the

accompanying narrowing of the interest rate differential had negative impact of 1%. The short-term FX models are

outlined in Appendix 1, together with up-to-date estimates.

2% 2%7%

19%

-1%

4%

20%

40%

9%

25% 21%32%

10%

36%42%

101%

6%

2%6%

18%

-10%

10%

30%

50%

70%

90%

110%

1M 3M 6M 12M

Commodity returns


CRB FuturesBrent OilCopperIron OreSoybean

5.04.94.9

4.24.14.03.9

3.63.3

3.02.82.8

2.52.42.42.42.4

1.81.7

1.00.90.80.8

-0.5-1.5

-9.0

-10 -8 -6 -4 -2 0 2 4 6

NZDZARAUDNOKSEKCLPPLN

KRWBRLCADCHFTWDJPY

COPGBPCZKEURHUFSGDMYRCNYRUBIDRINR

MXNTRY

Monthly absolute FX returns


%, (+) appreciation(-) depreciation

3%

0%

2%

28%

-2%

-11% -11%-12%

4%

0% 1%

11%

3%1%

5%

15%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

1M 3M 6M 12M

Latam FX - spot retuns


BRLMXNCLPCOP

13

15

17

19

21

23

25

Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

BRL's volatility premium recedes


BRL implied volatility Average volatility of large

EMs*

%, at-the-money(6-month)

* peers: Mexico, South Africa, Turkey and Russia

https://www.itau.com.br/itaubba-en/economic-analysis/publications/macro-brazil/narrowest-current-account-deficit-since-2007


We present below a qualitative discussion of each currency separately and summarize the key aspects of our

analysis.

BRL (Brazilian Real)

• Fundamentals: With a slightly more favorable external scenario for emerging-market countries, we now expect

less intense BRL depreciation. As U.S. interest rates increase (however gradually) throughout the year and

commodity prices drop from their current levels, the BRL is likely to depreciate from current levels: we are now

forecasting year-end exchange rates of 3.50/USD for both 2017 and 2018. This is in line with a scenario of a slight

increase in current account deficits, at levels that will not compromise external sustainability. Our scenario

assumes the approval of the Social Security reforms.

• Technicals: BCB retained a neutral stance over FX intervention in January. Despite some market talks that the

increase in the size of its daily rollover auctions (to USD 750 million from USD 600 million) was due to Chair

Yellen’s hawkish speech, we believe this was not the case. The new pace was simply due to a regional holiday in

São Paulo state on January 25, which would imply the expiry of roughly USD 1 billion of outstanding FX swaps

due in February under the previous offering (12,000 contracts per auction). In fact, Governor Goldfajn said in an

interview the BCB aims at keeping constant its short USDBRL position (roughly USD 26 billion). The technical

position is neutral. Using BM&F data on major players’ (domestic and foreign) USDBRL futures holdings, we see

that net long positions are essentially zero.

• Positioning: BCB’s decision to keep constant the volume of outstanding FX swaps contributed to the current

richness of the BRL; the tender is 8.3% stronger than the model estimate (1.6 standard-deviations). We see a

correction across the year towards 3.50/USD.

1%

-1%

2%

0%0%

1%

-1%0%

-1%

1%

1%

-1%

3%

1%

0%

1%

-2%

-1%

0%

1%

2%

3%

4%

5%

BRL COP CLP Latam

FX drivers: contributions to monthly returns


(+) appreciation(-) depreciation

Commodity PricesInterest-rate differential

ResidualCDS Spreads

-20%

-15%

-10%

-5%

0%

5%

10%

Jan-16 Apr-16 Jul-16 Oct-16 Jan-17

Deviations from model estimates


%, deviation from short term estimate

(+) cheap currency (-) rich currency

BRL (-1.6 s.d. from m.p.)COP (0.5 s.d. from m.p.)CLP (-1.7 s.d. from m.p.)

s.d. = standard deviationm.p. = model projection

-8.3%

-4.2%

2.3%


MXN (Mexican Peso)

• Fundamentals: We have revised our exchange rate forecast for 2017 upward (to 20.5, from 19.5), as the risk of

more protectionist policies in the U.S. has intensified. Recent concerns that the U.S. administration might disrupt

FDI inflows into Mexico and adopt more-protectionist trade policies have fueled the MXN’s volatility.

• Technicals: The Foreign Exchange Commission (formed by the Banxico and the Ministry of Finance) sold USD 2

billion in the spot market in the first week of the year without meaningful impact on the MXN. In its statement

about the decision, the FX Commission mentioned that it acted to mitigate volatility, rather than to defend a

specific exchange-rate level. IMM data shows the technical position remains skewed towards bearish territory.

• Positioning: The NAFTA notification carried out by President Trump’s government was already priced-in the

MXN. The currency’s short-term performance will likely be influenced by the development of the negotiations.

Looking further ahead, the tax reform debate will enter the spotlight and signs of the passing of a “border tax

adjustment” are bound to fuel the MXN’s volatility. Be that as it may, it is important to distinguish noise, which will

likely remain high at this early stage, from actual steps.

-15

-10

-5

0

5

10

15

20

Jan-16 Apr-16 Jul-16 Oct-16 Jan-17

BRL: technical position -USD futures (BM&F)


Institutional investors (nationals + foreigners)

USD billion (+) long USDBRL(-) short USDBRL


-100

-80

-60

-40

-20

0

20

40

60

80

100


MXN: technical position - CME futures

Source: IMM, Itaú

Net position (non-commercial)

in thousand contracts(+) long MXN (-) short MXN


CLP (Chilean Peso)

• Fundamentals: The prolonged economic weakness of the Chilean economy and accompanying deterioration of

the sovereign balance sheet led Fitch Ratings to revise the outlook to negative from stable. Afterwards, Standard

& Poor’s reaffirmed its AA- long-term foreign currency rating for Chile, while also revising the outlook to negative

from stable. The agency notes that the outlook revision reflects the risk that prolonged low economic growth could

translate into larger fiscal deficits than currently projected by it, leading to continued increase in government debt.

Even though we acknowledged a downward bias on our 1.5% GDP estimate for 2016 as well as on the 2%

recovery expected for this year, a sovereign downgrade remains outside the realm of our baseline scenario.

• Technicals: The technical position in the formal FX derivatives suggests market sentiment towards the CLP

remain upbeat. Looking at the notional amount outstanding of offshore investors, the volume of long USDCLP

positions are close to the 6-month median.

• Positioning: The copper rally pushed the CLP to overbought levels, according to our numbers. The Peso is 4.2%

stronger than the estimate, meaning a 1.7 standard deviations gap. This deviation does not provide much

opportunity to go long USDCLP, since we expect stability in Chinese growth in 1Q17, which could sustain the

copper bullish momentum and keep the CLP rich in the short term.

COP (Colombian Peso)

• Fundamentals: Legislators passed a modified tax-reform bill after discussions in the two houses of Congress.

The bill has undergone changes from the initial version submitted in October, but succeeds in raising revenue to

partially make up for the loss of oil income and will help compliance with the fiscal rule. By 2022, the expected

additional tax revenue will be around 1% less than planned in the initial proposal. Nevertheless, the reform would

help hold off fiscal concerns for the time being. This reform will likely ease the rating-downgrade risk in the short

term (Colombia currently holds a rating one notch above the minimum investment-grade level). In fact, S&P

reaffirmed, Colombia’s rating at BBB but maintained a negative watch, while Fitch would visit the country later in

the year before pronouncing itself on a revised outlook. In the medium term, we underscore that either an

expenditure adjustment or further reform will be necessary to ensure fiscal sustainability.

-12

-11

-10

-9

-8

-7

-6

-5

-4

May-16 Jul-16 Sep-16 Nov-16 Jan-17

CLP: technical position -formal FX derivatives market

Source: BCCh, Bloomberg, Itaú

Offshore investors

USD Billion

(+) long CLP (-) short CLP


• Positioning: The estimates from our FX model suggest the COP is a tad oversold. The current prices (as of

January 23), imply that it is 2.3% weaker than the fair-value. Though this deviation is statistically equal to zero, we

do have a constructive view on the COP. The moderation of the external current-account deficit and the timely

approval of key reforms ground our positive assessment of the Peso.

2) Rates

Overview

Long U.S. Treasuries halted the post-election widening trend in mid-December, as forwards (5y5y) reached the 3%

long-run median Fed guidance. Likewise, 5y5y implied inflation already stabilized a touch higher than the 2% inflation

target, suggesting that further upside in U.S. rates may be circumscribed to the front end.

In our revised U.S. scenario, we anticipate a decline in the unemployment rate to 4.3% by 4Q17 (20bps below the

FOMC’s December forecast) and see the balance of risks tilted to the downside given that business investment may

spur stronger payroll growth. We now forecast three Fed rate hikes in 2017 (from two previously) and continue to

expect another four hikes in 2018. A more preemptive Fed seems likely to mitigate the risk of a sharper

unemployment rate undershooting of the NAIRU over the next few years. Stronger activity data in the U.S. may lead

to an upward re-pricing of the odds of a FOMC hike in March and consequently put some pressure on LatAm yields.

Notwithstanding, we think Brazilian rates will likely outperform ahead, given the country’s improved external

fundamentals (e.g. the current-account deficit is the narrowest in LatAm).

Brazil Rates

As we expected, BCB reduced the Selic policy rate by 75bps at its January meeting. The communication revealed

that falling inflation has created an opportunity to front-load the monetary easing cycle. In the accompanying

communiqué, the board went as far as to signal the possibility of at least one more 75-bp cut in February - but did not

commit to delivering it. In our view, rising unemployment will continue to help bring down inflation, and given no

further uncertainty abroad, this will likely allow the central bank to maintain the new easing pace over the next

meetings. We thus expect two additional 75-bp cuts at the February and April meetings.

2

14

0

18

-1

-21

-7

10

-3

10

-5

-24

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

USA Eurozone Japan UK EMs Latam

Change in nominal yields (10-year)


YTDLast month

bps

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4


Forwards at the long-run guidance


U.S. Treasuries (5y5y)Implied inflation (5y5y, rhs)

%

USD p. b.

%


Medium-term inflation expectations overall converged to the 4.5% target. The latest Focus survey (as of January 20)

shows that two year-forward mean forecasts are only 3bps higher than the target. Asset-implied expectations are

currently running below the survey-based measure. In the long term (five years forward) the breakeven’ premium

over the Focus survey is roughly in line with the historical average (not including 2016). In fact, the average of 5-year

economists’ projections decreased further and is some 12bps below 4.5%. If inflation comes in below the center of

the target range this year, it may create an opportunity to discuss reducing the target (which must be set prior to June

30, according to the law) for the years ahead.

After a major re-pricing following the first Copom of the year as well as January IPCA-15, our analysis shows that DI

futures prices-in between 300bps and 350bps of rate cuts for 2017, broadly aligned with our scenario. We believe the

Selic rate is likely to reach 9.75% at YE17 (previously, we saw it at 10%), as the inflationary scenario is more benign

than we anticipated. Looking at 2018, we believe that the continued downward trend in inflation and our projection of

still-high levels of idle capacity in the economy are consistent with further interest rate cuts: we project a Selic rate of

8.50% at the end of 2018. We underscore that BCB’s guidance so far is consistent with a front-loading of the

monetary easing cycle but not, in principle, with a change in the total budget for monetary loosening.

250

260

270

280

290

300

310

320

330

10.5

10.7

10.9

11.1

11.3

11.5

11.7

11.9

12.1

12.3

12.5

Sep-16 Oct-16 Nov-16 Dec-16 Jan-17

Source: Bloomberg

Brazilian CDS x NTN-F 2025

% p.a. bps

CDS Spreads (rhs)NTN-F 2025

250

260

270

280

290

300

310

320

330

5.3

5.4

5.5

5.6

5.7

5.8

5.9

6.0

6.1

6.2

6.3

Sep-16 Oct-16 Nov-16 Dec-16 Jan-17

Source: Bloomberg

Brazilian CDS x NTN-B 2055

% p.a. bps

CDS Spreads (rhs)NTN-B 2055

4.53%

4.37%4%

5%

6%

7%

8%

9%

10%

Jan-13 Jan-14 Jan-15 Jan-16 Jan-17

Breakeven inflation vs. inflation forecasts (2-year)

Source: Bloomberg, BCB, Itaú

Breakeven (NTN-Bs, 1y1y)Survey Forecast (Focus, 2y)

% p.a.

avg. premium (2010-2015) = 0.62%

5.29%

4.38%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%


Breakeven inflation vs. inflation forecasts (5-year)


Breakeven (NTN-Bs, 4y1y)Survey Forecast (Focus, 5y)

% p.a.

avg. premium (2010-2015) = 0.99%


In all, we believe the current pricing is broadly consistent with the short-term path of monetary policy of our baseline,

given the available information. Putting it differently, the sizable premium previously embedded in the curve was

erased. Yields would have room to narrow further from current levels only if the market re-evaluates its expectation

for the terminal-Selic rate - something that requires the passing of structural fiscal reforms. The Lower House of

Congress will likely approve the proposed Social Security reforms, which are critical for achieving future compliance

with the spending cap, by the end of 2Q17.

Regarding the back end, we estimate that the 5y5y forwards price in a long-term Selic rate of around 11.3%, roughly

80bps above our theoretical terminal-rate estimate. This calculation is based on the assumption that the real U.S.

terminal rate is 1.0%, consistent with the long-term median “dot” of the December SEP1. Additionally, we set inflation

at the 4.5% target (a conservative estimate, given that some market participants are debating the possibility of a

reduction in the inflation target) and use the 10-year CDS spread (around 340bps) as a proxy for long-term Brazilian

country risk. Finally, we add a historical term premium estimate to arrive at an upper bound theoretical value of

10.5%.

1 Summary of Economic Projections.

7%

8%

9%

10%

11%

12%

13%

14%


Forward curve pricing (DI Futures) vs. analysts' projections


Market pricingMarket pricing (TP-adjusted*)

Itaú forecastConsensus forecast


% p.a.

* TP = Term-premium (historical)

-302

-20

-349

-59

-408

-36

-450

-400

-350

-300

-250

-200

-150

-100

-50

0

2017YE 2018YE

DI Futures: implicit rate hikes by...


Unadjusted for TP*Adjusted for TP*

Analysts' consensusbps

* TP = Term-premium

1.0%

3.4%

4.5%

1.6%

11.3%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Brazil

Theoretical value for terminal market rates in Brazil


Total:10.5%

p.a. U.S. real terminal rateCDS spread (10-year)

Domestic inflation mid-targetTerm premium (terminal)

Terminal rate expectations (5y5y)


Non-Brazil LatAm rates: Mexico, Chile and Colombia

The past 30 days saw diverging trends in LatAm risk. Chilean CDS spreads only accompanied the overall movement

in EMs. As per local rates, the Chilean curve bull-steepened slightly, consistent with BCCh’s easing guidance and

disappointing 4Q16 activity data. In turn, Colombia’s credit risk improved over the period, echoing the approval of the

structural tax reform.

On the other hand, Mexican risk premium widened amid the uncertainties surrounding the future of the U.S.-Mexico

trade relationship. We’ll discuss below the risks affecting Mexican assets rates.

The inflation outlook is heterogeneous as well. Chilean one year-forward inflation expectations fell below the 3%

target. As we’ll discuss in Chile’s subsection, we also expect inflation to remain within the lower half of the central

bank’s 2%-4% tolerance range throughout 2017. On the other hand, expectations in Mexico rose strongly, amid the

compounding of inflationary shocks (see below).

130

81

144

186

134

85

157165

126

83

174

153

50

100

150

200

EM

s

Ch

ile

Me

xic

o

Co

lom

bia

Credit default swaps (5-year)


As of January 231 month before6 months before

bps

28 27

19 18

8

-20 -22

-14-11

-15

5

9

-7

-21

5

-30

-20

-10

0

10

20

30

40

1Y 2Y 5Y 10Y 20Y

Monthly changes in swap rates


MexicoChile

Colombia

bps

4.68

4.25

2.90

2.5

3.0

3.5

4.0

4.5

5.0


Inflation expectations (1 year forward)

Source: Latin Consensus , Banxico, Banrep, BCCh, Itaú

% p.a.

MexicoChile Colombia

upper bound (4%)

target (3%)

* latest data derived from Latin Consensus

4.00

3.00

3.59

2.5

2.7

2.9

3.1

3.3

3.5

3.7

3.9

4.1

4.3

4.5


Inflation expectations(2 years forward)

Source: Latin Consensus , Banxico, Banrep, BCCh, Itaú

% p.a.

MexicoChile Colombia

upper bound (4%)

target (3%)

* latest data derived from Latin Consensus


Another symptom that Mexican assets are trading on stress-mode is the rates-FX correlation; the association

estimated on a 100-day window is close to unity even for longer rates (10-year). Accordingly, 5y5y forwards are

trading around 8.0%, touching the upper bound of our theoretical terminal rate proxy2.

We now analyze the current pricing and eventual trading opportunities in each market separately:

MEXICO

As far as monetary policy is concerned, Mexico can be regarded as an outlier within LatAm. Banxico is worried about

the occurrence of simultaneous shocks, which could derail inflation expectations. Therefore, we believe that the

Central Bank will tighten monetary policy more aggressively than we were previously expecting: we see a 50-bp hike

in the next meeting, followed by three 25-bp movements before the end of this year.

We view the front end-pricing of the TIIE swaps curve for 2017 as inconsistent with our Mexico’s baseline. Indeed the

curve sees excessive tightening for 2017: depending on the term-premium assumption, there are between 163bps

and 177bps of rate hikes implied in the front end. For next year, there are some 50bps in monetary easing (after

filtering out the term premium), in line with our scenario; we see room for two 25-bp rate cuts, amid lower inflation

and a better-behaved exchange-rate. Thus, we see value in receivers in the very front end (up to the 1-year), in order

to profit from a correction of the implied monetary policy path for the next 12 months.

2 We base our steady-rate U.S. real rate proxy on the December Summary of Economic Projections. The terminal median “dot”

implies a real rate of 1.0%. We also set the expected terminal inflation of each country to their inflation targets (all have a 3% target). To control for country risk, we use the 10-year CDS spreads, which are running around 240bps for Mexico, 130bps for Chile and 230bps for Colombia.

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17

Rates-FX correlation in Mexico

Source: Bloomberg, ItaúSource: Bloomberg, Itaú

Correlation coefficient (100 days)

1Y TIIE Swap2Y TIIE Swap5Y TIIE Swap10Y TIIE Swap

critical level

1.0% 1.0% 1.0%

2.4%1.3%

2.3%

3.0%

3.0%

3.0%

1.7%

1.0%8.0%

4.5%

7.4%

0%

2%

4%

6%

8%

10%

12%

14%

Mexico Chile Colombia

Theoretical value for terminal market rates in Latam


U.S. Real terminal rateCDS spread (10-year)

Domestic inflation mid-targetTerm premium (terminal)

Terminal rate expectations (5y5y)

% p.a.

8.1%

6.3%

8.0%


Turning to the back end, the unwind of gasoline prices’ subsidies is positive, since, according to the government, the

benefit would have generated fiscal expenditures as high as 1% of GDP per year. Thus, the frontloading of the

adjustment of gasoline prices will contribute to the achievement of the 0.4% primary surplus target in 2017, rendering

a rating downgrade less likely. Be that as it may, the political landscape will be the key risk factor to monitor. The

markets will watch the regional elections’ outcome (June 2017) in order to gauge the chances of each party in the

presidential election of 2018 and, importantly, the likelihood that the next administration will maintain sound economic

policies. In all, the long end seems too-risky for us, given the non-traditional uncertainties affecting the Mexican

economy in 2017.

The same holds for implied inflation. Even though breakevens escalated on the compounding of multiple one-off

inflationary shocks (15% rise in the liquefied petroleum gas price, 10% minimum wage adjustment, hikes in 14 state

taxes, higher electricity prices and the hefty weakening of the MXN), we prefer to wait for more information on the

future U.S. policies. Additionally, it will be key to monitor the domestic scenario in order to gauge if Banxico will

manage to avert significant second-order effects of the inflationary shocks, particularly over inflation expectations.

5.25%

5.75%

6.25%

6.75%

7.25%

7.75%

Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19 Jan-20

Forward curve pricing (TIIE swaps) vs. analysts' projections

Source: Bloomberg, Latin Consensus, Itaú

% p.a.


Market pricingMarket pricing (TP-adjusted*)Itaú forecastConsensus forecast

162

-14

149

-43

104 103

-100

-50

0

50

100

150

200

2017YE 2018YE

TIIE swaps: implicit rate hikes by...


bps

* TP = Term-premium

Unadjusted for TP*Adjusted for TP*Analysts' consensus

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

Mexican breakeven inflation rates (spot)


2-year5-year

% p.a.

lower bound

upper bound

target


CHILE

As expected, BCCh cut its monetary policy rate by 25bps to 3.25% in January, after being on hold for a full year. The

decision follows disappointing November activity and inflation ending 2016 below expectations. The press release

announcing the decision retained the same loosening bias, thus supporting our expectation of more easing ahead.

The latest IPoM indicate a cycle of only 50bps, but we anticipate further monetary easing given the expectations of

weak growth and inflation set to hover within 2-3% for a significant part of 2017.

The market pricing converged to our scenario, virtually erasing the 50-bp gap between the cuts implied in Camara

swaps for 2017 and our call that BCCh will take the policy rate to 2.25% (i.e. a 100-bp easing cycle). As of January

23, the curve sees between 97-107bps in cuts for the year – pending on the term premium assumption. Looking to

2018, a partial easing of the monetary stimulus would take place later in 2018 (we see the policy rate ending next

year at 3.25%), as activity picks up and inflation gradually returns to the center of the target range. The curve prices-

in just one 25-bp hike, suggesting some upside for the 2-yr/3-yr sector.

On a separate note, the senate approved Rosanna Costa as the replacement for Rodrigo Vergara in BCCh’s board.

She will fill in the remainder of Vergara’s period as board member (until December 2018). She was head of the

Budget Office at the FinMin during the Piñera administration (2010-2014) and currently is deputy director of think-

tank Libertad y Desarrollo. She also belongs to the National Council for Productivity. Until 1993, she served as an

economist at the Central Bank of Chile, and between 1993 and 2010 she conducted research on fiscal matters,

government modernization, and capital markets. Rosanna Costa is an economist from the Catholic University in

Chile.

COLOMBIA

The minutes of the December meeting, show that a majority of the board believes that the conditions are sufficient to

reduce the contractionary policy stance. So, although we think Banrep will proceed cautiously with rate cuts, we now

see the policy rate ending this year at 5.5% (6.0% in our previous scenario), implying 200bps in rate cuts for this

year. The IBR swaps curve currently prices in less than 175bps in rate cuts (assuming our term premium

hypothesis). For 2018, there is a divergence as well: the curve implies 45-90bps in cuts whereas we see the central

bank taking the policy rate to 4.50% (i.e., further 100bps in cuts).

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 Jan-22

Forward curve pricing (Camara swaps) vs. analysts' projections


% p.a.


Market pricingMarket pricing (TP-adjusted*)Itaú forecastConsensus forecast

-92

46

-102

25

-30

21

-120

-100

-80

-60

-40

-20

0

20

40

60

2017YE 2018YE

Camara swaps: implicit rate hikes by...


bps

* TP = Term-premium

Unadjusted for TP*Adjusted for TP*

Analysts' consensus


We believe the case for receiving the back end has strengthened in recent days. Although the tax-reform bill has

undergone changes from the initial version submitted in October, it succeeds in raising resources to partially make up

for the loss of oil revenue thus helping to comply with the fiscal rule and increased the odds of retaining the sovereign

investment grade. In fact, S&P ratings affirmed Colombia’s BBB rating and kept negative the outlook. According to

the agency “the negative outlook reflects the risk that we could lower our ratings on Colombia if its external balance

sheet or its fiscal debt burden do not improve within the next 18 months”. We read this as a positive development,

given that in late 2016 part of the market was considering a one-notch downgrade as the baseline scenario. Some

even saw the risk of a downgrade with the maintenance of a negative outlook. The affirmation by S&P underscores

that, even though the recently approved tax reform was diluted, it managed to ease concerns over fiscal

sustainability for now. In addition, the improvement of the (still-high) current account deficit probably contributed to

the rating decision. Another piece of evidence that market sentiment towards Colombia improved was the high

demand observed for Colombia’s international bond issuance in January. According to the Finance Ministry,

Colombia placed USD 2.5 billion: USD 1 billion are due in ten years and the remaining regard the reopening of the

2045 Bono Global (issued in Jan/2015).

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

Dec-16 Dec-17 Dec-18 Dec-19 Dec-20

Forward curve pricing (IBR swaps) vs. analysts' projections


% p.a.


Market pricingMarket pricing (TP-adjusted*)

Itaú forecastConsensus forecast

-149

-49

-177

-94

-160

-238

-300

-250

-200

-150

-100

-50

0

2017YE 2018YE

IBR swaps: implicit rate hikes by...


bps

* TP = Term-premium

Unadjusted for TP*Adjusted for TP*Analysts' consensus


Appendix 1: FX models

Our short-term financial models can be understood as extended-UIP (uncovered interest parity), whereby we model

FX trends using as regressors U.S. and local (market or benchmark) rates, the country risk premium (CDS spreads

as proxy) and commodity prices (for oil, copper and/or CRB, depending on the currency). The final set of explanatory

variables and the significance of the slopes will naturally change accordingly with the currency being modeled.

To estimate the OLS regressions, we used a monthly sample starting in 2011, so as to capture the recent dynamics

in LatAm FX. One shortcoming of our methodology is that our models do not account for (long-term) current account

balance conditions, yet the outlook for the external accounts may be indirectly embedded in CDS spreads (one of the

explanatory variables). These models may yield a good approximation of short-term trends, since FX tends to

behave as an asset price in the short run. In the long run, however, balance-of-payment conditions prevail as an FX

driver. Thus, our models are likely to lose accuracy over longer horizons.

0.170.12 0.11

-0.23

0.01

-0.21

0.28

0.08 0.07

-0.48 -0.49

-0.37

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

USDBRL USDCOP USDCLP

FX Rate Sensitivity

Source: Bloomberg Itaú

elasticity estimates

monthly data (Jul-11 to Dec-16)

U.S. Treasury yields (2y)Local yields (short-end)

CDS spreadsCommodity prices

1.8

2.3

2.8

3.3

3.8

4.3

4.8


BRL vs. projection


Actual levelModel projectionInterval: +/- 1 std. dev. (6-year window)

USD/BRL

12

14

16

18

20

22

24

26


MXN vs. projection


USD/MXN



Appendix 2: CDS valuation model - Brazil

Our valuation model for Brazilian 5-year credit spreads was introduced in the October issue of our Monthly. The

variables used are: (i) GDP-weighted average of EM spreads; (ii) the steepness of the U.S. Treasuries curve (2s30s);

(iii) non-commercial net long positions on the AUD normalized by open interest; (iv) the real exchange rate

(normalized to have zero mean and unitary variance); (v) the ratio of the trailing 12 months internal federal

government nominal interest payments divided by the 12-month average federal domestic securities debt; (vi) a

numeric scale based on the qualitative rating provided by the three major rating agencies and (vii) an indicator

variable of whether or not Brazil holds investment grade status by at least two agencies. The latter is used to partial

out the impact of external shocks over Brazilian country-risk when it is deemed investment grade and when the

country holds a high-yield status.

550

600

650

700

750

800

850


CLP vs. projection


USD/CLP

Actual levelModel projectionInterval: +/- 1 std. dev.(6-year window)

1,700

1,950

2,200

2,450

2,700

2,950

3,200

3,450

3,700

3,950


COP vs. projection


USD/COP


10

60

110

160

210

260

310

360

410

460

510

Jan-06 Nov-07 Sep-09 Jul-11 May-13 Mar-15 Jan-17

Model adherence to the data


CDS spreads (5-year)Fitted values

bps

-3

-2

-1

0

1

2

3

Jan-06 Nov-07 Sep-09 Jul-11 May-13 Mar-15 Jan-17

CDS model signals


Component not explained by the model (Z Scores)

One standard devation

https://www.itau.com.br/itaubba-en/economic-analysis/publications/latam-fi-strategy-monthly/latam-markets-remain-stable-but-the-risks-are-mounting


Appendix 3: Itaú macro projections (vs. consensus)

For a thorough macroeconomic discussion, see LatAm Macro Monthly – Stronger global growth, not in LatAm (yet),

January 20

Itaú Itaú Survey Itaú Survey

Real GDP growth - % -3.8 1.0 0.5 4.0 2.2

CPI - % 10.7 4.7 4.7 4.0 4.5

Monetary Policy Rate - eop - % 14.25 9.75 9.50 8.50 9.38

BRL / USD - eop 3.96 3.50 3.40 3.50 3.50

Itaú Itaú Survey Itaú

Real GDP growth - % 2.6 1.6 1.8 2.1 2.3

CPI - % 2.1 4.6 4.4 3.3 4.0


MXN / USD - eop 17.40 20.50 21.04 19.50 20.84


Real GDP growth - % 2.3 2.0 2.1 2.5 2.8

CPI - % 4.4 2.8 3.0 3.0 3.0


CLP / USD - eop 709 685 682 695 682


Real GDP growth - % 3.1 2.3 2.4 2.8 3.1

CPI - % 6.8 4.3 4.5 3.5 3.9


COP / USD - eop 3,175 3,080 3,050 3,175 3,033

Source: Itaú, Latin Consensus Forecasts, BCB, Banxico, BCCh, Banrep, Bloomberg

2018F

2018F

2018F

2018F

MACROECONOMIC FORECASTS

2017F

2017F

MEXICO

COLOMBIA

CHILE

2017F

2017F

2016

2016

2016BRAZIL

2016




Appendix 4: LatAm rates trackers (Updated as of January 26, 2016 – closing prices)

Brazil

Amount

Outstanding

Modified

DurationLast Price Δ1M Δ1Q Δ1H Δ1Y

(BRL Billions) (Years) (% a.a.)

CDI RATE - - 12.88 -75 -100 -125 -125

Feb-17 0.0 12.88 -46 -72 -103 -192

Apr-17 - 0.2 12.49 -47 -89 -119 -246

Jul-17 - 0.4 11.84 -57 -114 -153 -330

Oct-17 - 0.7 11.33 -57 -126 -172 -401

Jan-18 - 0.9 10.96 -61 -131 -184 -455

Jul-18 - 1.4 10.59 -62 -126 -189 -529

Jan-19 - 1.9 10.47 -61 -108 -173 -568

Jul-19 - 2.4 10.50 -63 -91 -159 -581

Jan-20 - 2.9 10.58 -62 -78 -144 -581

Jul-20 - 3.4 10.68 -65 -66 -132 -576

Jan-21 - 3.9 10.73 -65 -54 -120 -571

Jan-23 - 5.9 10.96 -64 -35 -100 -563

Jan-25 - 7.9 11.05 -61 -29 -94 -569

Jan-26 - 8.9 11.07 -60 -30 -95 -578

Jan-27 - 9.9 11.11 -59 -32 -93 -582

Apr-17 69.6 0.2 12.49 -35 -90 -118 -230

Jul-17 60.1 0.4 11.81 -56 -117 -158 -317

Oct-17 63.6 0.6 11.32 -57 -129 -173 -386

Jan-18 62.0 0.8 10.91 -63 -140 -189 -442

Apr-18 68.1 1.0 10.76 -59 -132 -190 -477

Jul-18 57.0 1.3 10.60 -59 -128 -190 -514

Oct-18 52.2 1.5 10.51 -61 -137 -186 -

Jan-19 90.9 1.7 10.48 -62 -112 -175 -547

Jul-19 36.7 2.2 10.53 -59 -91 -161 -554

Jan-20 68.1 2.6 10.59 -63 -82 -146 -560

Jul-20 70.1 3.1 10.73 -63 -66 -130 -

Jan-18 15.3 0.8 10.93 -65 -137 -185 -436

Jan-19 11.2 1.6 10.37 -71 -122 -180 -537

Jan-21 98.9 3.0 10.70 -65 -49 -120 -552

Jan-23 97.4 4.1 10.90 -58 -30 -95 -548

Jan-25 65.5 5.0 10.91 -54 -23 -80 -560

Jan-27 40.5 5.8 10.95 -48 -32 -85 -577

May-17 46.6 0.3 5.79 -66 -106 -95 -26

Aug-18 60.5 1.4 5.69 -29 -54 -78 -35

May-19 69.9 2.0 5.65 -30 -45 -68 -67

Aug-20 59.2 3.0 5.68 -32 -33 -51 -102

May-21 68.9 3.6 5.71 -33 -29 -48 -144

Aug-22 98.9 4.4 5.77 -29 -21 -35 -151

May-23 50.5 5.0 5.72 -31 -21 -34 -163

Aug-24 51.5 5.7 5.66 -33 -21 -36 -172

Aug-26 25.1 6.8 5.68 -33 -18 -28 -177

Aug-30 32.7 8.8 5.56 -29 -5 -21 -174

May-35 56.9 10.8 5.60 -31 -14 -25 -193

Aug-40 44.2 12.2 5.55 -30 -13 -21 -192

May-45 82.6 13.4 5.64 -24 -9 -20 -190

Aug-50 136.3 14.2 5.59 -29 -11 -17 -192

May-55 21.4 15.1 5.55 -30 -5 -20 -195

Source: Bloomberg (BGN), Itaú

(basis points)

DI

Fu

ture

sL

TN

RE

AL

RA

TE

S

NT

N-B

NT

N-F

NO

MIN

AL

RA

TE

S


Mexico

Amount

Outstanding

Modified


(MXN Billions) (Years) (% a.a.)

TIIE Rate - - 6.15 4 103 156 259

3-month - 0.2 6.46 24 123 177 283

6-month - 0.5 6.79 28 142 187 307

9-month - 0.7 6.99 26 152 190 319

1-year - 1.0 7.19 28 162 196 332

2-year - 1.9 7.41 25 170 191 318

3-year - 2.7 7.53 17 170 184 292

4-year - 3.5 7.63 17 170 182 270

5-year - 4.2 7.75 18 171 185 253

7-year - 5.4 7.93 - 169 187 219

10-year - 7.0 8.13 - 169 189 194

15-year - 9.0 8.32 14 158 177 164

20-year - 9.8 8.49 16 156 179 149

30-year - 10.8 8.69 - 159 184 149

Jun-17 114.7 0.4 6.47 28 136 162 269

Dec-17 159.1 0.8 6.45 34 141 173 -

Jun-18 211.1 1.3 6.71 16 134 153 231

Dec-18 210.0 1.7 6.78 10 135 143 214

Dec-19 169.5 2.6 6.95 9 126 147 189

Jun-20 96.2 2.9 7.06 14 132 154 185

Jun-21 269.9 3.7 7.24 18 138 158 174

Jun-22 115.4 4.4 7.35 17 143 160 163

Dec-23 93.1 5.2 7.45 21 145 163 152

Dec-24 238.2 5.6 7.50 15 143 161 151

Mar-26 107.1 6.7 7.57 14 142 160 138

Jun-27 86.5 7.1 7.68 19 142 160 134

May-29 93.1 7.7 7.81 23 142 163 128

May-31 137.8 8.5 7.94 26 143 166 123

Nov-34 100.7 9.4 8.04 30 143 164 121

Nov-36 61.3 9.4 8.07 31 144 167 118

Nov-38 105.6 10.0 8.09 27 143 165 117

Nov-42 147.6 10.8 8.05 26 138 162 109

Dec-17 111.6 0.9 0.99 -61 -18 -5 -58

Jun-19 160.7 2.3 2.17 -37 -12 27 -25

Dec-20 97.2 3.7 2.45 -22 3 34 -20

Jun-22 120.6 5.1 2.68 -22 9 34 -24

Dec-25 182.6 7.4 3.07 - 25 53 -10

Nov-35 122.1 13.0 3.71 -1 41 65 -1

Nov-40 247.5 15.4 3.82 2 42 64 -2

Nov-46 121.3 17.5 3.85 0 42 66 -2


UD

IBO

NO

RE

AL

RA

TE

S

(basis points)

TII

E S

wa

ps

NO

MIN

AL

RA

TE

S


Chile

Amount

Outstanding

Modified


(CLP Billions) (Years) (% a.a.)

Interbank Rate - - 3.50 - - - 0

3-month - 0.2 3.10 -22 -38 -42 -52

6-month - 0.5 3.05 -18 -34 -47 -64

9-month - 0.7 3.00 -18 -35 -51 -77

1-year - 1.0 2.96 -17 -36 -53 -87

18-month - 1.5 2.97 -17 -31 -56 -96

2-year - 2.0 2.99 -15 -25 -49 -95

3-year - 2.9 3.20 -9 -11 -42 -85

4-year - 3.8 3.42 -6 -1 -29 -75

5-year - 4.6 3.63 -5 7 -18 -65

6-year - 5.4 3.78 -6 12 -13 -59

7-year - 6.2 3.93 -6 16 -8 -56

8-year - 7.0 4.05 -8 17 -5 -52

9-year - 7.7 4.15 -7 20 -1 -51

10-year - 8.3 4.22 -6 20 0 -46

15-year - 11.2 4.37 -10 19 -1 -40

20-year - 13.5 4.45 -9 20 -3 -44

Mar-17 170.2 0.0 3.05 - - - -98

Jan-18 450.0 1.0 3.31 - -20 - -74

Mar-18 344.1 1.0 3.31 - - - -75

Jan-19 290.0 1.9 3.31 -16 -22 -58 -86

Jan-20 762.5 2.8 3.58 - -3 - -68

Mar-21 700.0 3.9 3.68 -11 -13 -45 -

Jan-22 475.4 4.5 3.79 - -3 - -54

Jan-24 530.0 5.4 4.03 - - - -48

Mar-26 1,348.0 6.8 4.17 -19 -1 -24 -43

Jan-32 464.7 10.2 4.38 -17 -8 -35 -44

Jan-34 415.0 10.9 4.39 -14 -4 -34 -37

Mar-35 547.0 11.2 4.46 -7 0 -39 -36

Jan-43 1,176.3 14.0 4.60 -16 1 -22 -34

Jun-17 175.0 0.0 3.32 -6 -16 -33 -73

Mar-18 246.8 1.0 3.27 -14 -23 -44 -89

May-18 83.6 1.0 3.27 - -28 - -77

Jun-18 243.2 1.0 3.27 -16 -28 -48 -86

Jan-19 400.0 2.0 3.35 -13 -19 -48 -

Apr-20 450.0 2.9 3.60 -7 -8 -43 -66

Jun-20 900.0 2.9 3.56 -12 -14 -48 -71

Jul-20 450.0 2.9 3.41 -16 -25 -56 -86

Feb-21 470.0 3.7 3.81 - -2 - -49

Mar-22 350.0 4.5 3.78 - -2 - -55

Mar-23 245.0 4.9 3.88 -28 -3 -32 -52

May-17 202.5 0.3 1.76 - - - 106

Jul-17 326.2 0.4 1.40 27 -6 29 51

Jan-18 346.4 0.9 0.91 - - - 11

Mar-18 602.3 1.1 0.85 - -25 - -6

Jul-18 437.4 1.4 0.81 - -27 - -13

Aug-18 213.1 1.5 0.77 -19 -29 -31 -21

Oct-18 146.5 1.6 0.74 - - - -20

May-19 25.3 2.2 0.85 - - - -27

Feb-21 1,157.3 3.7 0.89 - -17 - -29

Mar-22 605.0 4.7 0.92 - -15 - -38

Sep-22 219.6 4.9 0.92 - - - -39

Mar-23 289.3 5.5 1.03 -23 -5 -23 -47

May-28 302.0 9.6 1.37 -12 4 -16 -30

Feb-31 736.5 11.5 1.49 -12 4 -18 -27

Feb-41 736.5 17.6 1.79 -9 16 -1 -11


BC

P

NO

MIN

AL

RA

TE

SR

EA

L R

AT

ES

(basis points)

CA

MA

RA

Sw

ap

sB

TP

BC

U


Colombia

Amount

Outstanding

Modified


(COP Billions) (Years) (% a.a.)

IBR Rate - - 7.14 0 -23 -21 160

3-month - 0.0 6.77 -15 -61 -64 66

6-month - 0.2 6.48 -15 -80 -102 13

9- month - 0.5 6.30 -6 -81 -113 -13

1-year - 0.7 6.17 -3 -77 -119 -29

18-month - 1.2 6.03 4 -62 -122 -49

2-year - 1.7 5.67 6 -48 -115 -76

3-year - 2.6 5.58 -5 -37 -109 -106

4-year - 3.4 5.64 -10 -32 -96 -123

5-year - 4.2 5.78 -13 -26 -88 -127

7-year - 5.7 6.01 -23 -23 -74 -145

8-year - 6.4 6.16 -21 -18 -68 -145

10-year - 7.6 6.38 -26 -15 -58 -144

12-year - 8.2 6.46 -28 -26 -59 -164

15-year - 9.0 6.58 -24 -17 -52 -186

Oct-18 9,678 1.5 6.23 -18 -16 -97 -136

Nov-18 10,233 1.7 6.10 -11 -19 -105 -134

Sep-19 13,740 2.3 6.24 -17 -28 -97 -163

Jul-20 19,472 2.8 6.31 -23 -34 -91 -173

May-22 18,256 4.1 6.39 -29 -40 -97 -223

Jul-24 26,890 5.2 6.61 -29 -34 -79 -204

Aug-26 18,481 6.6 6.77 - -49 -91 -228

Apr-28 13,804 7.5 6.98 -37 -46 -74 -236

Sep-30 14,500 8.3 6.94 -42 -46 -82 -250

Apr-19 9,909 2.1 2.03 -44 -76 -92 -99

Mar-21 14,329 3.7 2.46 -34 - -65 -124

Feb-23 14,548 5.1 2.79 -30 - - -87

Mar-33 8,664 12.2 3.48 - - - -105

Apr-35 3,296 12.2 3.50 -16 -4 -31 -


(basis points)

IBR

Sw

ap

sU

VR

CO

LT

ES

RE

AL

RA

TE

SN

OM

INA

L R

AT

ES


Appendix 5: Closed recommendations


Relevant Information

1. This report has been produced by Itaú Corretora de Valores S.A (“Itaú BBA”), a subsidiary of Itaú Unibanco S.A., regulated by the Securities and Exchange Commission of Brazil (CVM),

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instrument, or to participate in any particular trading strategy in any jurisdiction. The information herein is believed to be reliable as of the date on which this report was issued and has

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accuracy of such information, nor does this report intend to be a complete statement or summary of the investment strategies, markets or developments referred to herein. Opinions,

estimates, and projections expressed herein constitute the current judgment of the analyst responsible for the substance of this report as of the date on which it was issued and are,

therefore, subject to change without notice. Prices and availability of financial instruments are indicative only and subject to change without notice. Itaú Unibanco Group has no obligation

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