Sovereign Macro- Weekly Latin America Market Outlook

Sovereign Macro- Weekly Latin America Market Outlook

November 29, 2021

Summary: the world is scrambling to adapt to the news about the Omicron variant of COVID. This has already resulted in international travel bans and some mobility restrictions that will have an impact on the economic outlook but so far, the prospect of far more harmful hard lockdowns appears distant. The knee jerk risk off and a flight to quality reaction was expected after such news, and perhaps amplified by the low liquidity during the US holidays. The question is where we go from here and what are the policy choices open to the FED since it has already started tapering. In my opinion, and assuming there are no hard lockdowns, the FED has 3 choices. One, is to suspend tapering completely to gauge the complete picture of the situation. It seems extreme given the level of immunization and the work that labs are already doing to produce a new vaccine, likely in about 100 days. More importantly, inflation is a problem today unlike it was at the start of the pandemic. Two, to accelerate tapering as many in the board have suggested but by a small amount for instance to 20bn/month and communicate that the board is trying to balance the risks to the labor market and high inflation. Three, keep the same tapering at 15bn/month saying that the outlook continues to depend on the evolution of the pandemic but reasserting its commitment to act more forcefully if inflation persists thus giving it slight precedence over jobs. I don’t think that anyone in their right mind would suggest adding to fiscal or monetary stimulus, but Omicron can certainly be used as a political argument to pass the BBB bill. Adding stimulus would exacerbate the supply demand imbalances and ultimately lead to higher inflation. In my view, markets’ assessment of what the FED will do in its next meeting will change daily. If the FED’s decision was this week, I would be calling for option three and since the FED’s job is to look through these events, I would expect that the DOTS move more decisively toward neutral through 2024. But again, we will know a lot more by the time the FED has to make a policy decision. In the weekend talk shows, Scott Gottlieb, a Pfizer board member, sounded more optimistic: “If you talk to people in vaccine circles, people who are working on a vaccine, they have a pretty good degree of confidence that a boosted vaccine, so three full doses of vaccine, is going to be fairly protective against this new variant”.

We have an action-packed week. The US congress will have to pass a continuing resolution to keep the government funded after December 3, along party lines. Work in the senate will resume to pass the BBB bill before Christmas amid the strong opposition of the usual suspects. We will pay special attention to FED speakers to see their potential reactions to Omicron, Powell, Williams, Bostic, Barkin, Daly and Bullard. Yellen will appear alongside Powell in a congressional testimony. December payrolls are also on the docket; strong jobless claims suggest a good NFP and continued pressures on wages. We will have the opportunity to see more indicators of price pressures in the PMIs, home prices and Conference Board price expectations. Elsewhere, inflation in the UK and Europe will grab particular attention. The reaction of BOE officials to the inflation/Omicron combo will be important since they have been leaning more toward a hike in the December meeting. OPEC will meet to decide on their plans to increase output in response to the lame release of strategic petroleum reserves and Omicron after a week of significant downward adjustment in prices.

In the region, I will follow the impact of CFK’s letter to the pace of Argentina’s negotiations with the IMF. In Brazil, I will be paying attention to the communication from Bacen after, yet another, strong inflation print. RCN tried, somewhat successfully, to convince markets that a pace of 150bp/meeting was still appropriate. The recent decline of oil prices will help alleviate pressures on gasoline and allow Bacen to keep the pace. But I would say that markets were more animated because of recent polls that show that a “third way” was more feasible with the appearance of Sergio Moro of Podemos. Joao Doria of PSDB should provide another alternative but my concern is that Moro and Doria can potentially cannibalize the center voters and reduce their chances of entering the second round. This week we will have the vote in commission of the Precatorios bill which remains in a state of flux. During the week we will have activity indicators including q3 GDP which is expected to have slowed sharply and could end with a negative print. In Chile we will continue to see the ramifications of the victory of Kast in the first round and its implications for the second, and what it would mean in a potential government. The voters sent a strong message of moderation against the extreme left, including the communist party. Kast is already assembling an impressive economic team which will have to do some serious work on his tax proposals. There are many unanswered questions in Chile and risks are high in the second round of the presidential election and in the output of the constitutional assembly, but recent developments make me more constructive on the story and should help stabilize the currency and flatten the curve as well as ease pressure on CDS. We will have data on economic activity during the week. Mexico will still be trying to figure out what to make about the future of monetary policy. On the data front Banxico will provide a new inflation report, where I don’t expect big changes, if any, to their most recent projections of inflation, and the latest survey of expectations. During the presentation, it will be important to follow the message of the governor considering the most recent minutes, and also potentially statements by other members during the press conference. But the biggest elephant in the room is what policy implications come out of the nomination of Victoria Rodriguez for governor. She will be confirmed this week. The new configuration of the board will be on net, dovish. I believe that she will try to avoid changes to the policy path of 25 bp -despite 2 members clearly indicating their willingness to accelerate the pace- in her earlier decisions but there is always the risk that we revert to a pause. This would be obviously negative since the normalization if policy is not even close to being done. We will see her first statements early in 2022, but my initial reaction, that we will see a bear steepening of the curve, stands. Let me say a couple of things about the possible reasons of changing the nomination of Herrera for Rodriguez at Banxico. AMLO has two significant objectives, one is to continue to fund his projects, the airport, the Maya train, the refinery and to keep Pemex alive. Those require substantial resources which in normal circumstances would be obtained by a combination private investment or new debt. But the president opposes both and that is why he has tried to extract money from Banxico twice, through the FX profits and through the monetization of the new IMF SDR allocation. Thankfully, he has failed due to the strong standing of the board which has defended the rule of law. We don’t know Herrera’s stance on these issues, but it seems that as a good economist and respectful of the law, he sided with the central bank. This may have forced the president -among other things- to reconsider Herrera’s loyalty, anticipating that it would be extremely difficult to make him cooperate with his objectives. A back of the envelope calculation shows that Banxico’s FX profits for this year could be as high as the equivalent of 2% of GDP and the president will want that money. The new governor and the board will not doubt be tested again. That is however excellent news for Pemex bondholders.

Jaime Valdivia

Sovereign Macro

Founder and Chief Economist

jaime.valdivia@sovereignmacro.com