Sovereign Macro- Weekly Latin America Market Outlook

November 8, 2021

Summary: Except for the Bank of England’s decision to postpone the inevitable start of its gradual hiking cycle -on concerns about the strength of the labor market and notwithstanding their own forecast for high inflation through the spring- central banks globally continued their march to normalize their policies. The FED finally announced the start of tapering which should end by June of next year at which point rate hikes are realistic, the precise timing will depend on whether the FOMC believes it achieved its nebulous definition of maximum employment. Powell said the FED will adopt a “risk management approach” which provides ample leeway to move the goalposts as necessary. Last week’s payroll numbers were very strong, but workers remain reluctant to rejoin the labor force, wage pressures are an ongoing concern despite the FED’s opinion. The RBA suspended its YCC and admitted that rates could increase before 2024 despite markets pricing hikes next year already. Poland surprised with 75bp hike and Czech with 125bp and promised to do more. The minutes of central banks in Brazil and Colombia augur more hikes at a faster pace. During the week Banxico and BCCH released their latest surveys of expectations. In both cases inflation and the path of policy rates were revised upward, more in Chile than in Mexico. The latest survey in Chile challenges the BCCH’s idea to get to 3.5% policy rate by next meeting especially because expectations up to 24 months are well above the target while the economy remains red hot. Inflation expectations continued to rise in Mexico now for the 6^th month in a row and are now above 3.8% into 2022 and 3.6% in the next 1-4 years. Recent inflation dynamics and upward revisions to expectations in a context of higher global rates may force Banxico to reconsider its own pace. Look out for my preview during the week.

The coming week is full of action. In the US after passing the bipartisan infrastructure bill, the moderate democrats conditioned their support for the larger social infrastructure bill to a formal CBO score because they suspect the bill is much larger than the portrayed 1.75tn. The Penn Wharton model already scored it at more than 4tn over ten years. These democrats committed to voting on this by November 15. As is, it is difficult to see how this bill passes and major changes or concessions will have to materialize to have a chance. We’ll have inflation this week which is expected to print 5.9% annually from 5.4% in September. We will have the usual parade of FED speakers post FED decision and the focus will be their views on inflation and rates normalization; expect a wide range of opinions. Argentina will hold its congressional elections where results are expected to favor the opposition after it trounced the government coalition in the recent primaries. An IMF program looks no closer and a coalition loss may push the agreement further out. Brazil faces a most important week regarding the fate of the precatorios. The house passed the bill with 312 of the minimum 308 votes needed and scheduled a second-round vote for Tuesday. More importantly, on the same day, the Supreme Court will start to vote whether it upholds the decision of Justice Rosa Weber stopping the release of monies to congressmen due to lack of transparency. It is alleged the so called “enmendas do relator” which are budgetary allocations to specific congressional districts, have been used to buy votes. In the two days prior to the vote, 900mn BRL worth of those amendments were released to congressmen to motivate their support according to the press. Without those payments it is difficult to see how the vote can reach 308, some argue. Moreover, there are other legal challenges to the vote since there appear to be serious procedural irregularities. IBGE will announce inflation for October. Expected at more than 1%, it will push the annual number to 10.5%; focus will be on services which already had a strong showing in IPCA-15.  Chile will release inflation on Monday which is expected to print slightly below 1% for the month and we will have another expectations survey. In Colombia Banrep will release its latest expectations survey as well as activity indicators. In Mexico INEGI will release October inflation which is expected at 0.8% for headline and 0.5% for core, very high either way. It is concerning that average monthly core inflation since the beginning of the year is at an annualized 6% in a context of a cumulative MXN depreciation of 2% and a strong real appreciation. These week’s numbers would be consistent with annual headline inflation of 6.2% and core of 5.2%. As in every other country that I follow, the behavior of core will be very important. It has recently gathered strength in the US, Brazil. Chile and Mexico inducing downward rigidity to core inflation. At the same time core goods inflation appears to have stabilized but at high levels and its eventual downward trend may be a bit flatter than believed. Sticky inflation is what there is in the menu for 2022.

US:

• ELECTIONS AND INFRASTRUCTURE BILLS: The elections in the US shifted the balance of power toward a more center to center right type of ideas. The concept of larger government accompanied by higher taxes didn’t sit well with the electorate that rejected more government intervention, of the intrusive kind, in education, healthcare and social services. That said, denial of the political reality is pushing progressives and the Democratic party as a whole to double down on their aspirations pushing through with the vote of reconciliation bill ignoring voters and warnings from moderate democrats. The reconciliation bill needs major changes among other things because a proper score shows a cost of more than 4tn over 10 years and not 1.75. Without a doubt, this will increase the deficit notwithstanding Yellen’s misleading comments to the contrary.
• PAYROLLS: Blowout numbers for both the establishment and household surveys with significant upward revisions to September and August. Gains were widespread mainly in service sectors like Leisure and Hospitality, Professional and Business Services and Warehousing and Transportation, and Manufacturing also did very well. Job gains in private sector services industries were 496k, and 108k in goods industries comprising Mining, Construction and Manufacturing. The shortfall of jobs against February ’20 stands now at 4.7mn. Challenges remain, however, for instance the employment/population ratio was at 58.8 well short of the 61.1 prior to the pandemic and the LFP declined reflecting still resistance to rejoin the labor force. The increase in AHE reached 4.9% in October. While Powell downplayed wage pressures citing the ECI, other indicators show that pressures are stronger. Incidentally the John Deere labor union rejected what appeared to be a very generous offer of wage increases -10% right away- and bonuses. Let’s see what happens.
• PMIs: they were a mixed bag. Headline came in line with expectations, but orders fell well below and declined by about 7 points, still at an expansionary level. Employment improved in October, but prices paid were well above the expectation and jumped about 4.5 points. The bright side were inventories which continued to recover for the third month in a row giving some hope that supply chains may be decongesting a bit.

ARGENTINA:

• IMF: there is a lot of noise surrounding the negotiations with the IMF, suggesting “waivers”, renegotiation of surcharges and other crazy stuff. The bottom line for me is that none of that will happen. The staff will have to negotiate -as usual- an economic plan that -with a high probability- allows Argentina to meet its obligations to its creditors and opens access to international capital markets. There is no cutting corners. There is of course leeway but there is no other way. I believe that given the confluence of political and economic factors there is a significant risk that Argentina defaults to the IMF as well as all of its other international creditors. If Argentina defaults to the IMF, it will be a very painful path to return to international capital markets. The country would still, have to negotiate a program with the IMF -a Rights Accumulation Program- during which it would not receive any cash but would cancel its past due obligations upon meeting the negotiated performance criteria. This is likely to take several years. When bond prices are this low, it is usually for a reason. I sincerely hope that the government gets its act together but must confess that after the elections, a doubling down of the failed policies is likely and should surprise no one.
• ELECTIONS: the country will have congressional elections where half of the seats of the lower house and a third of the senate will be up for grabs. Polls indicate a worsening for the government coalition compared to what happened in the primaries a couple of months ago.

BRAZIL:

• MINUTES: reiterated a hawkish stance adopting a new baseline pace of hikes of 150bp per meeting and moving to a significantly more restrictive stance. Fiscal risks to the outlook were important in Bacen’s decision as well as the unfavorable inflation dynamics that, in its opinion, were linked to commodities prices and the currency devaluation recently. In my view, the sharp increase in services inflation, including core, should’ve been highlighted as a potential risk
• PRECATORIOS: with 312 votes in the LH the precatorios law was modified and created a space of around 92bn BRL for 2022 between the adjustment for inflation since 2016 and limiting payments of precatorios from 2022. The IFI (Independent Fiscal Institute) believes that 64bn will go to social spending and the rest will be used for congressional amendments and electoral spending. The bill now undergoes amendments and requires one more vote in the plenary to pass -likely on Tuesday- and head to the senate for two rounds of votes. Justice Rosa Weber stopped the “enmendas do relator” which are budgetary allocations to congressmen and their districts to implement their programs. She alleges that the process lacks transparency because the beneficiaries (congressmen) are anonymous. It gave congress 30 days to provide more information of the process. Without this potential financial inducement, the vote of the second round of precatorios this week looks uncertain. There are also procedural challenges to the vote for instance because the speaker allowed remote voting -which is now banned- and because he introduced new features in the bill that the commission had no knowledge of.
• POLITICS: As a result of the support of his party, the PDT, in favor of the approval of the precatorios law, Ciro Gomes threatened to withdraw his candidacy for President. He is considered by some a moderate leftist alternative to Lula. Lula himself hasn’t confirmed his intention to run. The buzz continues around a potential “third way” that could challenge the extremes of Bolsonaro and Lula. The field will start to take shape before year end with Sergio Moro potentially entering the race with Podemos, and the primary of the PSDB between Leite and Doria. There are 12 months to go to the election, but politics will take an increasing part in market dynamics in my view.

CHILE:

• TRADERS’ SURVEY: there were substantial revisions to inflation and policy rates. 12 and 24 months ahead inflation expectations are now at 5.4% and 3.8% respectively with upward revisions of 70 and 30bp. The policy rate expectation for the next three months is at 5% implying another hike of 125 bp in December followed by one of 100bp in January thus challenging the BCCH’s intention of getting to 3.5% by December with a hike of only 75bp more from current levels. As a result, the survey implies a forward real policy rate of 0.1% 12 months ahead and of 1.1% 24 months ahead. I wonder if the real forward rate between zero and 1% is enough to keep expectations converging to 3% in the policy horizon. With inflation expectations 24 months out at 3.8%, a further tightening of the screws may be required.
• 4^TH PENSION CASHOUT: to be debated on Nov 10 in the senate
• PRESIDENTIAL POLLS: right wing candidate Kast is ahead with 25% of the vote according to the latest polls of Panel Ciudadano-UDD followed by Boric at 2%. The economic programs of both raise concerns about the fiscal outlook. While Boric’s intention to increase government revenues by about 8% in 8 years, Kast’s tax cuts would easily lower revenues by 30%. Neither appears realistic. I know that this is the campaign but who would have thought that congress would approve 4 withdrawals of pension accounts a year ago. And yet here we are.

COLOMBIA:

• MINUTES: there were upward revisions to growth and inflation. The economy is expanding even faster than previously thought, it generated 1mn jobs in q3 alone and with that, almost 90% of the losses since the pandemic started have been recovered. Economic slack is declining fast. 5 members of the board argue that keeping the level of accommodation at current levels may compromise price stability and inflation expectations and could reinforce indexation practices. Some noted the significant recovery of private consumption through a strong expansion of credit. Others questioned the capacity of the economy to meet the strong demand pressures to avoid an inflationary surge and a deterioration of the external imbalances. The majority thought that increasing rates by 50bp reduced the risk if having to act more aggressively in the future. Those in the minority thought the 25 bp pace was appropriate because there was much uncertainty about the pandemic and recent price increases were due to global factors, the pandemic and road blockades, and would fade. They argued that accelerating the pace would have a negative effect on consumption and small and medium size companies.
• INFLATION: October inflation came much lower than expected at zero vs, 22bp expectation. The main reason was the Zero-VAT day that lowered prices of a number of goods.
• ELECTIONS: Petro still leads in the polls followed by Fajardo in a distant second

MEXICO:

• BANXICO SURVEY: in the latest report, expectations through 2022 were revised up, in some cases significantly. Headline for the next 12 months was up 22bp to 3.86% for the fifth month in a row, and core 10 bp to 3.78% for the sixth month in a row. Headline for this year was up by 35 bp now at 6.63% and core was revised up by 28bp to 5.3%. revisions for end 2022 were mild with 4bp for headline to 3.84% and 11bp to core to 3.83%. longer term expectations of 1-4 years stayed at 3.6% and 5-8 years at 3.5%. All of these remain well above the target. expectations clearly continue to move higher. The survey also had policy revisions including a 25bp revision to this year’s rate to 5.25% thus expecting a 25 bp hike in November and December. The survey also revised higher the rate for 2022 from 5.5% to 6% and is expected to stay at that level through 2023. Revisions to growth were mild to 2.9% for 2022 from 3% and 2% in 2023
• ELECTRICITY REFORM: Morena coalition decided to postpone the debate of electricity reform under alleged pressure from the US ambassador

Jaime Valdivia

Sovereign Macro

Founder and Chief Economist

jaime.valdivia@sovereignmacro.com