As usual, we’re keeping it brief. Email us at if you’d like to dialogue further on anything you see below.
All is not well under the hood.
On the whole, Latin American equity markets had a great week, closing up +1.9% on a median basis. The gains were led by Mexico’s IPC Index (+2.7% wk/wk) and Chile’s Stock Market Select was the only market to close down (-0.2% wk/wk). Mexico’s gains are being supplemented by growing speculation of a rate cut as the country’s economic growth slows, and that was reflected in the FX market (MXN/USD down -1.3% wk/wk), the bond market (Mexico’s 2yr sovereign debt yields -12bps wk/wk), and the interest rate swaps market (Mexico’s 1yr on-shore interest rate swap spread declined -27bps wk/wk).
From a credit quality perspective, the broad-based backup in 5yr CDS is definitely noteworthy and could imply that last week’s gains in Latin American equity markets were more short-covering oriented or speculation around QE3, rather than actual investing.
Brazil: The big news out of Brazil last week centered on fiscal policy. First, it was announced that the manufactured-product tax on cigarettes will be increasing by +40% on Dec. 1, with an additional +23% in both 2013 and 2014, and a final +18% by 2015. The move is expected to increase the retail price of cigarettes by +20% this December, and by +55% through 2015. We’re not ones for higher taxes or big government, but we welcome Brazil’s resolve to chip away at its deficit, as increasing the country’s gross national savings rate is a major need ahead of Brazil’s lofty infrastructure initiatives over the next ~3 years.
YTD, Brazil has been delivering on the fiscal side regarding its primary surplus (July’s R$11.2 billion was the best ever for that month), but, as we point out in our Brazil Black Book, the government’s insistence on spending for large regulatory agencies and social welfare projects limits their ability to run an actual surplus due to elevated interest rates as a result of inflation. A meaningful down-shift in Brazilian government expenditures would be very bullish for the Brazilian economy over the long-term TAIL.
Nearer term, credit growth in Brazil continues on its white-hot pace in July, growing +19.8% YoY and +1.1% MoM (vs. June readings of +19.9% and +1.5%, respectively). As we also point out in our Brazil Black Book, interest rates are simply too low to contain credit growth in Brazil and the central bank is likely to be on hold for much longer than the Brazilian bond and interest rate markets believe, as it targets +15% YoY credit growth in 2011 vs. the current YTD pace of +20.4%. Interestingly, consumer credit continues to grow at breakneck speeds (+17.9% YoY in July vs. +18.1% in June) while consumer credit metrics continue to deteriorate (default rate accelerated to +6.6%; delinquency rate accelerated to +13.5%) – despite the unemployment rate hitting a YTD low in the same month (6%)! If the August consumer confidence reading is any indication (118.7 vs. 124.4 in July), we should expect to see further deterioration (on the margin) in Brazil’s consumer credit story.
Mexico: Banco de Mexico held its benchmark interest rate at a record low 4.5% for the 21st straight meeting, amid “growing uncertainty over the European and U.S. economic outlooks.” The move was also supported by the data: CPI rose a mere +9bps MoM in the first half of August (a two-month low) and Mexico’s trade balance fell -148.5 million pesos YoY (vs. +444.4 million YoY in June). As the Indefinitely Dovish theme continues to dominate Mexican monetary policy, we continue to own the bearish intermediate-term outlook for Mexico’s currency, the peso (MXN).
Chile: The big news out of Chile last week came in the form of massive, and sometimes violent, demonstrations in central Santiago. Over 80 unions and social organizations sent members and supporters to the Central Workers Union’s planned two-day work stoppage, which is estimated by the government to have cost the country around $400 million total. In a similar theme to the driving force behind Ollanta Humala recently being elected president of Peru, the Chilean lower-middle class is upset that the country’s record growth rates are not adequately benefiting the lower level of society. As such, the government is in a process of renegotiating wage agreements and labor laws with Chilean social organizations, such as the recent wage settlement with a prominent public health union. Despite aggressive speech out of Finance Minister Filipe Larrain, recent activity would suggest the billionaire president Sebastian Pinera continues come to the table ready to negotiate.
From an economic data perspective, Chile’s central bank president Jose De Gregorio continues to walk down his 2011 economic growth estimates closer to our own, saying, “[We are] seeing signs of a deceleration in demand growth that might accelerate in the rest of the year.” He also suggested that the central bank might change the “trajectory” of Chilean monetary policy, should the global economy decelerate enough to warrant it – a statement which received a major “duh” from the market. In a sign that Gregorio’s statement wasn’t “news”, Chile’s 1yr interest rate swaps spreads actually increased +6bps wk/wk.
Peru: The key developments out of Peru last week centered largely on the role of the state within the economy and how that would affect international relations. The “dreaded” mining windfall tax was officially announced and the aggregate burden of $1.1 billion per year for the industry actually came in perhaps much lighter than many were expecting earlier in the year. Humala continues to lead from the center and, thus far, he has not announced anything overly punitive for the private sector. In fact, Prime Minister Salomon Lerner has officially stated that Peru’s economic policy priorities are “integration” and “international cooperation”, with the specific intent on broadening regional ties and strategic partnerships with Asia. If they are successful in doing this over the next 3-5 years, we’ll gladly admit to having been wrong on Humala, because this would likely mean he’s serious about his claims to engage the private sector from the center, rather than the far-left of the political spectrum.
Regarding fiscal policy, Humala continues to be a socialist and it will be interesting to see if the recently announced national employment program (“Trabaja Peru”), which is designed to create one million new jobs by 2016 and +200k in the “short term”, is ultimately financed with higher corporate tax rates later on down the road. Finance Minister Miguel Castilla also said that the country is readying a countercyclical public spending plan – should one prove necessary. Again, with Peruvian policymakers quick to fire the spending gun, it will be interesting to see how they plan to finance such initiatives over the coming years. On one hand, they could tax the private sector directly. On the other, they could tax them indirectly by allowing inflation and interest rates to back up as the sovereign’s fiscal metrics deteriorate. Either way, a tax is a tax and socialism remains socialism – despite its many forms of obfuscation.
Argentina: The alarm bells continue to ring very, very loud in Argentina. As capital flight continues near its record pace ($9.8 billion through June and $18 billion projected for the year by former deputy economy minister Jorge Todesca), the central bank is stepping up its sale of FX reserves to the most in two years ($700 million MTD – the highest since June ’09). This is done to minimize peso (ARS) devaluation in the spot market. Interestingly, the government’s recent move to consolidate banking data is actually facilitating the capital flight, with the gap between the USD/ARS spot exchange rate and the USD/ARS unregulated exchange rate widening to over 25 centavos. Argentina’s unregulated FX market is key to keep an eye on in times of heightened risk aversion, as it typically correlates well with a global flight to safety trade (speed counts).
The broad-based rush out of Argentinean assets is being perpetuated by the likelihood that President Cristina Fernandez de Kirchner wins a second term in the upcoming presidential elections (scheduled for October). She’s already secured 50.1% of the votes in the most recent primary, meaning she’s well on her way to pursuing more deficit and devaluation strategies in 2012. Interestingly, newspaper El Cronista reported that the government plans to increase government spending by +20% next year, meaning that either a large upcoming tax increase or currency devaluation is in order. The latter is due to the fact that Fernandez likes to use Argentina’s “free and available” FX reserves on fiscal spending and the pile of reserves deemed “free and available” have fallen to lowest level in over a year – likely necessitating a currency devaluation, lest the Argentinean government decides to tap international debt markets for the first time since its record $95 billion default in 2001.
Obviously, currency devaluation and using FX reserves to fund public expenditures is extremely inflationary. Yet, the Argentinean government insists inflation is only running at +9.7% YoY – so much so that they continue to punish private economists who suggest inflation is much higher at rates around +25% YoY. They’ve even modeled in CPI to be “less than +10%” in 2012, which we find interesting, given their recent decision to grant Argentinean labor unions a +25% increase in minimum wage. In most economies, minimum wage growth is typically only slightly north of the rate of inflation. Perhaps the government is not as adept at hiding the truth from the reported numbers as they believe themselves to be…
Venezuela: The key developments to highlight out of the Venezuelan economy last week were slowing growth and a sovereign debt downgrade. Real GDP growth slowed in 2Q to +2.5% YoY vs. a +4.8% rate in 1Q. Interestingly, Venezuelan economic growth had only been positive for two quarters over the last two years prior to this current slowdown, suggesting Chavez’s big spending on housing and agricultural projects ahead of next year’s elections aren’t helping the economy grow much beyond the budgeted +2% run rate. Perhaps if he refocused government efforts to rein in the country’s +26.1% YoY consumer price inflation instead of increasing social spending, Venezuela might actually have a great deal more real economic growth to report. On the credit rating front, S&P downgraded the sovereign’s debt rating to B+ (four notches below investment grade), citing regulatory instability via “changing and arbitrary laws” – such as Chavez’s recent decision to nationalize the country’s gold mining industry.