Brazil, Chile, and Mexico all reported higher than expected CPI data for December today, and continues a region-wide trend after Colombia and Uruguay did the same earlier this week.
Peru delivered an unexpected 25-basis point hike Thursday despite a slight easing in inflation in December, and we expect continued tightening from the region in 2011.
Brazil monetary policy outlook for a 50 basis-point hike on Jan. 18 to 19 was cemented after December IPCA inflation rose 0.63% month over month and 5.91% year over year. This is the highest year-over-year rate since November 2008, when the policy rate was at its pre-Lehman high of 13.75% for that cycle.
We expect at least 200 basis points of total tightening in 2011 compared to market expectations of 150 basis points, as we believe inflation could edge closer to the upper limit of the 2.5% to 6.5% target band in the coming months.
According to the last survey by the central bank, inflation expectations continue to creep higher, now at 5.32% for 2011 and also well above the 4.5% target. USD/BRL continues to have trouble breaking 1.70, despite the FX measures taken this week.
If the central bank embarks on the aggressive tightening cycle that we expect, USD/BRL is likely to retest the 1.6435 low in the coming weeks, and we expect any break of that area to bring on more FX measures. For now, investors seem to be playing the 1.65 to 1.70 range.
Chile
Chile reported inflation of 3.0% year over year in December, the highest since May 2009 and right at the central bank's 3% target (+/- 1 percentage point). Given how strong the economy is currently, we expect price pressures to continue rising towards the top end of the target range in the coming months, and the weaker CLP in the wake of the intervention program announcement will add to price pressures.
Still, USD/CLP is having trouble breaking above 500, and we believe that currency strength will resume after the announcement shock wears off. The central bank meets Jan. 13, and the market is currently split about the prospects for another 25 basis points from the current 3.25%.
We think a hike is likely that would take the policy rate to 3.5%, and we note that the market expects 225 basis points of total hikes in 2011 that would take it up to 5.5%.
We think tightening could be even greater, and the rising yield attractiveness (as well as strong economic fundamentals) should lead to resumption of CLP gains and a potential retest of the 2011 low around 465. Note that policy rate pre-Lehman high was 8.25% for that cycle.
Columbia
Colombia reported inflation of 3.2% year over year in December, the highest since September 2009 (when the policy rate was 4%) and above the central bank's 3% target (+/- 1 percentage point).
Here too, we expect price pressures to continue rising towards the top end of the target range in the coming months. The central bank meets Jan. 28, and is expected to keep rates steady at 3.0%. However, the economy is gaining momentum and so the tightening cycle is likely to start in the first quarter, with markets looking for 100 basis points of tightening in 2011 that takes the rate to 4% at year-end.
Here too, the risk is for even greater tightening and we note that policy rate pre-Lehman high was 10.0% for that cycle. The peso has been on fire recently after spiking above 2000 briefly. After the break of 1880 this week, USD/COP now appears on track to test the 2010 low around 1783. Officials expressed concern about peso strength last fall when it was rallying below 1800.
As such, we would expect markets to get nervous again about possible FX measures on another approach of the 1800 area.
Mexico
Mexico reported inflation of 4.4% year over year in December, the highest since March 2010 and well outside the central bank's 3% +/- 1 percentage point target range. MXN already enjoys a nice yield advantage at 4.5%, second highest in the region behind Brazil. Note that policy rate pre-Lehman high was 8.25% for that cycle.
What's more important, we believe Mexico policy-makers are not that concerned about peso strength as much as others in EM and so we see low risk of intervention or capital controls for MXN. Note that BRL, CLP, COP, and PEN have all almost fully retraced their post-Lehman losses, while MXN has lagged behind. For USD/MXN, there is little in the way of chart points once you get past the 2010 low around 12.13. There's a retracement level around 12.05, and then the bottom falls out and so peso gains could really accelerate on a break of 12.
Peru
Peru reported inflation of 2.1% year over year in December, right near the center of the central bank's 2% +/- 1 percentage point target range. The central bank just met and unexpectedly hiked rates by 25 basis points to 3.25%.
The Peruvian economy remains very strong, and market is looking for another 75 basis points of tightening that would take the year-end policy rate to 4%. However, there is a risk of greater than expected tightening this year given the strong momentum in the economy.
GDP rose 8.3% year over year in October vs. 10% year over year in the third quarter. Note that policy rate pre-Lehman high was 6.5% for that cycle. Despite the positive economic backdrop, the authorities remain concerned about currency strength.
The central bank has intervened regularly this past year to prevent sol strength but has so far refrained from any other types of controls. Near-term target is last year's low in USD/PEN around 2.7835, but it will likely be a slow grind lower.
