Download COLOMBIA—CB Hikes 25bps As Tightening Cycle Continues

COLOMBIA—CB Hikes 25bps As Tightening Cycle Continues
November 27, 2015
In today’s decision, the Banco de la República returned the pace of tightening to 25bps,
taking the total since the September launch to 100bps in hikes. In the previous meeting
in October, in an effort to re-anchor inflation expectations, the Central Bank had increased
a surprise 50bps, simultaneously announcing an FX call options program (similar to
implemented by the Comisión Cambiaria in Mexico), that sells USD$500 million in call
options when the official FX rate settles more than 7% above the 20-day moving average.
Kathryn Rooney Vera
Head of Research
[email protected]
+1 786.871.3758
COLOMBIA--Y/Y "Other Goods" Index Vs. Headline CPI. Source: DANE, CB, Bulltick LLC
10%
9%
Headline CPI
Other Goods
8%
7%
6%
5%
4%
3%
2%
1%
0%
Jan-02 Oct-02 Jul-03 Apr-04 Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 Oct-11 Jul-12 Apr-13 Jan-14 Oct-14 Jul-15
Instant Reaction: We had forecasted this rate hike as part of a tightening cycle and expect
the Central Bank to continue to react to the latest aggressive upswing in headline CPI to
avoid the real intervention rate from entering negative territory (which itself would risk
the 2016 inflation target). We think the CB will hike the repo rate to 5.75% by the middle
of 2016 in order to anchor inflation expectations, which remain above the 2% to 4% CB
target range through minimum end-2016. The unexpected surge in headline inflation in
recent months (October +5.89% y/y) was a bad leading indicator for the future pace of
inflation, forcing the CB to act in order to arrest negative expectations.
60%
COLOMBIA--Y/Y FX Depreciation, Vs. Y/Y Consumer Prices, Y/Y (Right Axis). Source:
Bulltick, CB, Bloomberg
10.00%
50%
9.00%
40%
8.00%
30%
7.00%
20%
6.00%
10%
5.00%
0%
4.00%
-10%
3.00%
-20%
2.00%
COP Curncy
Y/Y Inflation
-30%
Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15
1.00%
We continue to recommend investors carry trade the belly of Colombia’s local curve,
irrespective of the fact that the CB will most likely be forced to further increase interest
rates. In our view, the local curve has already priced in virtually all of the possible negative
news that may be forthcoming. We also think that maintaining long exposure on USD
sovereigns at current levels makes sense. We see the Colombia 2024s rallying from 4.29%
as of 11/27/15 to 3.72% by year-end 2015, consistent with our view on the US 10-year
ending 2015 at 2.2%, and spreads tightening somewhat on lower risk aversion
(“Goldilocks” environment, i.e. materially lower VIX).
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The CB likely wished to avoid adversely impacting economic activity with too drastic a pace of rate-tightening (in
maintaining a 50bp tightening pace), despite accelerating inflation prints and inflation expectations and a
dramatically weakened FX (24% weaker v. USD year-to-date).
It is worth highlighting the central bank’s communique:
Inflation Concerns: The CB notes October annual CPI inflation stood at an elevated 5.89% y/y and the average of the
four measures of core inflation at 5.11% y/y saying, “These results exceeded the projections of the Bank's technical
team and the market average. Measures of inflation expectations increased: the analysts at one and two years stood
at 4.4% and 3.6%, respectively, and those arising from government debt papers 2, 3 and 5 years beyond 4%. The
acceleration of inflation so far this year is mainly explained by the transfer of the nominal consumer prices and the
increase in costs of imported raw materials depreciation, as well as the less dynamic in the food supply. The transfer
of part of the devaluation of the peso in consumer prices and an El Niño strong slow the convergence of inflation to
the target, both because of its direct impact on prices and inflation expectations, as possible activation of indexing
mechanisms.
Domestic Considerations: The new figures for the third quarter, especially retail sales, suggest a more dynamic
domestic demand than expected. Net exports have subtracted from growth. On the supply side, industrial production
showed a positive trend and indicators of offices and cement production suggest a favorable dynamics of
construction…With this information and with the new data of economic activity in October, the technical team
maintained the growth forecast for 2015 from 2.4% and 3.4%, with 3% a more likely figure. Rising inflation
expectations measures have substantially reduced the measures of real policy interest rates and of the financial
system. At the same time, domestic credit growth remained above the rate of increase of GDP.”
Global concerns: “The figures for global economic activity continue to reflect weak dynamics and inferior to that of
2014. In the United States domestic demand is growing at a favorable rate while foreign demand while the euro area
is only recovering slowly. In China the slowdown continues and major economies of Latin America have low growth
or contraction of the product.
FED, USD, FX: “The likelihood higher now that the Fed will raise its benchmark interest rate in December; rates on
long-term bonds rose. The dollar appreciated and prices of major commodities declined. The price of oil fell below
that projected by the technical team. The fall in the terms of trade recorded throughout the year has deteriorated
national income and largely explains the higher level of the exchange rate against the dollar.
“In short, inflation expectations have increased and the risk of a slowdown in domestic demand, beyond consistent
with the decline of national income, has moderated. In order to ensure convergence of inflation to the target of 3%
decided to increase by 25 basis points interest rate benchmark, continuing the phase of monetary policy tightening
initiated in September.”
Bottom-line For The Markets
(1) FX Market: We expect pressure to come off of the DXY going into 2016 as the US economy is not healthy
enough to be able to grow at or above potential if the USD continues to appreciate. The US will not prove immune
to the travails of a downshifting world economy. In addition, just as we argued in our September and October
monthly publications, we consider that a significant US deceleration materializing in 2016 is not a small risk. Our
base case remains that the US economy avoids a recession, and that world markets instead reenter a “Goldilocks”
state, one that will be supported by enlarged monetary stimulus packages from Japan, Europe, and China. In
addition, we remain convinced that China will announce additional fiscal stimulus in the very short-term (most likely
in the form of lower consumption taxes and increased spending support for the poorer population). If our view fails
to materialize, 2016 could prove to be a year similar to the tumultuous 1997.
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10,000
Weekly US Oil Production (Left Axis, In Thousands Of Barrels Per Day) And Total
Active Rotary Rigs In The US (Right Axis). Source: Bakker Hughes, Bloomberg, DOE
1800
9,000
1600
8,000
1400
7,000
1200
6,000
1000
5,000
800
4,000
US Total Oil Production
Poly. (US Total Oil Production)
3,000
Bakker Hughes Index (Rotary Rig Count)
600
2,000
Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 Jun-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16
400
Another key structural backbone of our view on the markets remains our conviction that oil prices will find
stability and head higher going forward, because of lower supply and a weaker USD. We continue to think that if
oil prices fall further, the US high yield market will face a tumultuous year in 2016 (i.e. the markets could suffer a
systemic event on the materialization of massive shale oil defaults). We expect pressure to come off of the DXY
Dollar index, and, see support and appreciation for USDCOP in 2016.
105
COLOMBIA--USDCOP (Right Axis, Inverted), DXY (USD Index, Left Axis). Source:
Bulltick Capital Markets, Bloomberg
$1,600
$1,800
100
$2,000
95
$2,200
DXY Index
USDCOP
$2,400
90
$2,600
85
$2,800
$3,000
80
$3,200
75
Nov-11
$3,400
Mar-12
Jul-12
Nov-12
Mar-13
Jul-13
Nov-13
Mar-14
Jul-14
Nov-14
Mar-15
Jul-15
Nov-15
(2) Fixed Income: Consistent with our view on the future performance of the FX rate and the difficulties that the Fed
is facing at this time to initiate its highly anticipated “policy normalization” strategy, we continue to believe that
international “excess” capital has no longer-term alternative other than to carry trade, because the developed world
will continue to be affected by major deflationary forces for years to come. If our view on the incapacity of the US
economy to resist a persistent appreciation of the USD proves accurate (US consumer unable to carry the global
economy because the US consumer is not experiencing relevant increases in income levels), then the world’s buy-side
will have no other possible alternative than to once again carry-trade in high yielding currencies, such as the USDCOP,
the USDMXN, the USDTRY or the USDBRL. That is the reason why we continue to recommend investors to carry trade
the belly of Colombia’s local curve, irrespective of the fact that the CB will most likely be forced to further increase
interest rates going forward. In our view, the local curve has already priced-in virtually all of the possible negative
news that could be forthcoming (please see table in the next page for a schedule of standing recommendations).
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US--The Future Of US Intervention Rates (In Percentages, Nominal). Source: Fed,
Bloomberg, Bulltick
4.0
3.5
3.0
2.5
2.0
1.5
BULLTICK OVERNIGHT FORECAST
FED "POINT" FORECASTS (DECEMBER 2014)
1.0
US SWAP RATES
FED "POINT" FORECASTS (SEPTEMBER 2014)
0.5
FED "POINT" FORECASTS (MARCH 2015)
FED "POINT" FORECASTS (JUNE 2015)
FED "POINT" FORECASTS SEPTEMBER 2015)
0.0
1YR
2YR
3YR
4YR
5YR
6YR
7YR
8YR
9YR
10YR
11YR
12YR
15YR
20YR
25YR
30YR
40YR
50YR
We also think that maintaining long exposure on USD sovereigns at current levels makes good sense. Just as we
argued in a recent Colombia Update, we see the Colombia 2024s rallying from 4.23% at this time to 3.72% by yearend 2015, consistent with our view on the US 10-year ending 2015 at 2.2%, and spreads tightening somewhat on
lower risk aversion (“Goldilocks” environment, i.e. materially lower VIX).
TOTAL LOCAL DEBT RETURN SIMULATION (ASSUMES 5-YEAR HOLD STRATEGY)
INITIAL
INVESTMENT
CURRENT YIELD
FUTURE FX RATE THAT
BREAKEVEN FX
VALUE OF INITIAL INVESTMENT
TOTAL
EQUALIZES RETURN
DEPRECIATION VERSUS
AT T+5 YEARS (COMPOUNDED)
RETURN
(USD VERSUS LOCAL)
TIME T (TODAY)
US 10-YEAR BOND
$
100.00
2.22%
$
111.61
11.61%
COLOMBIA 10-YEAR, COP-DENOMINATED
$
100.00
8.23%
$
148.47
48.47%
$
4,236.47
36.86%
MEXICO 10-YEAR, MXN-DENOMINATED
$
100.00
6.09%
$
134.39
34.39%
$
20.33
22.78%
BRAZIL 10-YEAR, BRL-DENOMINATED (NY-LAW)
$
100.00
10.78%
$
166.85
66.85%
$
5.80
55.24%
BRAZIL NTN 2023, BRL-DENOMINATED
$
100.00
15.72%
$
207.51
107.51%
$
6.61
95.90%
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