Apr 6, 2017 - In Mexico, rates are high owing to depreciation of the peso in 2016, with resulting inflation, and a proac
Emerging Markets Institute Monthly perspective | April 6, 2017
Peso interest rates: outlook 2017 SUMMARY
More than US$19 trn. in developed country bonds at rates lower than 2% could switch to emerging market bonds with a higher return, but higher risk. In Mexico, rates are high owing to depreciation of the peso in 2016, with resulting inflation, and a proactive tightening cycle from Bank of Mexico. Debt market rates indicate economic slowdown, which could imply a rise in long term rates. For 2017 we expect more passthrough from peso depreciation to inflation but more moderate hikes from Bank of Mexico. In the face of foreseeable risks, short term inflation linked securities (ILS) should provide greatest protection to investors in the peso debt market.
“People don't realize that we cannot forecast the future. What we can do is have probabilities of what causes what, but that's as far as we go.” – Alan Greenspan Developed markets: rates stagnant, except US In a previous Monthly Perspective (“Negative rates: growth from monetary policy but global risks remain”, June 2016) we explored negative rates in developed markets (DM) owing to the 2008 financial crisis, and their persistence due to the long deleveraging process. A year later, things are relatively unchanged. The only developed world central bank that has begun to raise rates is the Fed, and it has done so very gradually (Figure 1). Developed world rates are in general close to zero. There is currently approximately US$6.5 trn. invested in negative rates and more than US$19 trn. invested in local currency bonds at rates below 2% (Figure 2). Figure 1. Fed target rate (31/March/2017). Source: Bloomberg
Figure 2. Global capital invested at different local interest rate levels (31/March/2017). Source: Bloomberg
1
Monthly perspective
April 6, 2017 Figure 2. Global capital invested at different local interest rate levels (31/March/2017). Source: Bloomberg
Franklin Templeton Servicios de Asesoría Mexico
Positive interest rates are available in DM local currency bonds, at longer terms, depending on the country. In Switzerland, there are positive rates at terms over 10 years. In Italy, bonds with positive rates can be bought at terms over 3 years (Figure 3). This is due to Italy’s higher sovereign risk than Switzerland. Figure 3. Developed countries: government bond local currency rates, by term (5/April/17). Source: Bloomberg
Emerging markets: higher rates In emerging markets (EM), things are different. With lower leverage and higher local rates (owing to higher sovereign risk) there was more room for maneuver during the 2008 crisis, and its long term effect was less intense. Currently most EMs have solid fundamentals, higher local real interest rates that are higher than DM, without having to extend terms (Figure 4). This could imply that, subject to the exchange rate outlook, funds could switch from low or negative real rates to higher positive real rates (nominal rates discounting inflation). Figure 4. DM and EM: central bank target real interest rates in local currency (31/March/2017) Source: Bloomberg 8
4 2 0 -2 -4 -6
-8
United Kingdom Sweden Spain Germany Denmark Norway Canada France Italy Switzerland United States Greece Japan Australia South Korea Thailand Chile Philippines Malaysia Indonesia Peru Colombia India Mexico China Russia Brazil Vietnam
Real interest rate
6
2
Monthly perspective
April 6, 2017
Mexico: current situation Franklin Templeton Servicios de Asesoría Mexico Mexico is a hybrid: an emerging market, but directly subject to the political and economic risks in the US, resulting from Trump`s election. Peso Owing to Trump`s protectionist rhetoric, the peso depreciated significantly during 2016. Sustained exchange rate depreciation generally causes inflation. In the first 9 months of 2016 (Jan-Sep), the peso depreciated from 17.24 to 19.37 pesos/US$ and depreciated in the period between the Trump election and inauguration (9/Nov/16 – 20/Jan/17), but after his inauguration returned to its pre-election level. These sudden currency changes do not necessarily cause inflation (Figure 5). Figure 5. Peso vs. US$ (31/March/2017). Source: Banxico
23 22 21 20 Depreciation that DOES cause inflation
19
Depreciation that DOESN'T cause inflation
18 17
Mar/17
Feb/17
Feb/17
Jan/17
Dec/16
Dec/16
Nov/16
Oct/16
Sep/16
Sep/16
Aug/16
Jul/16
Jul/16
Jun/16
May/16
May/16
Apr/16
Mar/16
Mar/16
Feb/16
Jan/16
Jan/16
16
Inflation Due to exchange rate depreciation, producer price inflation has reached a level close to 10%. This has affected consumer price inflation, but it is possible that complete passthrough has not yet occurred (Figure 6). Figure 6. Producer and consumer price inflation (%) (28/Feb/2017). Source: INEGI
12.0
10.0
8.0
6.0
4.0
2.0
Producer price inflation (12M)
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
0.0
Consumer price inflation (12M)
3
Monthly perspective
April 6, 2017
Sustained peso depreciation has begun to affect the prices of most categories included in the basic price basket Franklin Templeton Servicios de Asesoría Mexico used to calculate consumer inflation (Figure 7). Over the last 12 months, of 283 categories of the basket (e.g. tortilla and tomato) 28% showed price inflation above 4%. At the end of February 2017, this percentage had increased to 55%. This indicates that passthrough has occurred through all categories, i.e. that is has not been a one off phenomenon, as in the case of the gasoline price hike in January 2017. Figure 7. 283 categories in basic consumer basket over time (to 28/Feb/2017). Source: INEGI
100%
90% 80% 70%
60% 50% 40%
30% 20% 10%
Less than 0%
Between 0% and 2%
Between 4% and 6%
Above 6%
Feb/17
Dec/16
Oct/16
Jun/16
Aug/16
Apr/16
Feb/16
Oct/15
Dec/15
Aug/15
Jun/15
Apr/15
Feb/15
Dec/14
Oct/14
Jun/14
Aug/14
Apr/14
Feb/14
Oct/13
Dec/13
Aug/13
Jun/13
Apr/13
0%
Between 2% and 4%
Monetary policy Since the beginning of 2016, Bank of Mexico (Banxico) began to increase rates, raising its target rate from 3.25% in 2015 to 6.50% now (Figure 8). Banxico has emphasized that is it not in a tightening cycle, to contain growth, so much as responding to a depreciating peso, potential passthrough, and Fed policy. Figure 8. Banxico target rate (31/Mar/2017). Source: Banxico and Bloomberg
Banxico's target rate 7
6
5
4
3
2
1
Mar/17
Feb/17
Jan/17
Dec/16
Nov/16
Oct/16
Sep/16
Aug/16
Jul/16
Jun/16
May/16
Apr/16
Mar/16
Feb/16
Jan/16
0
4
Monthly perspective
April 6, 2017
Banxico`s monetary policy has been proactive, ahead of observed inflation (Figure 9). At its March 29 2017 meeting, Franklin Templeton Servicios de Asesoría Mexico Banxico indicated that it would diminish the rhythm of rate hikes. Target rates of 7 to 7.5% are expected for the end of 2017, with inflation between 5.5% and 6%. With these expectations, it is clear that, as Banxico has already moved, there is less pressure for more increases. Figure 9. Banxico: target rates and expected inflation 12 months. (31/Mar/2017). Source: Banxico and Banxico consensus
7.00%
6.00% 5.00% 4.00% 3.00% 2.00%
1.00%
Dec/14 Jan/15 Feb/15 Mar/15 Apr/15 May/15 Jun/15 Jul/15 Aug/15 Sep/15 Oct/15 Nov/15 Dec/15 Jan/16 Feb/16 Mar/16 Apr/16 May/16 Jun/16 Jul/16 Aug/16 Sep/16 Oct/16 Nov/16 Dec/16 Jan/17 Feb/17 Mar/17
0.00%
Expected 12M inflation
Target rate
Dr. Agustín Carstens, Banxico governor, has said that it is important to maintain the differential between Banxico and Fed target rates at historical average levels, around 4% (Figure 10). Currently this differential is at 5.5% (6.5% Mexico, 1% US). This could imply that short term, subject to exchange rate volatility, Banxico may not move when the Fed raises rates, to restore the historical average differential. This could indicate that Banxico could be near the end of its tightening cycle, or, at the least, that it will be less aggressive on rates during 2017. Figure 10. Banxico and the Fed: differential between target rates (%) (31/Mar/2017). Source: Banxico and Bloomberg
9 8 7 6 5 4 3 2
1
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
0
5
Monthly perspective
April 6, 2017
Nominal and inflation linked bonds Franklin Templeton Servicios de Asesoría Mexico Due to the inflation outlook as it unfolded during 2016, it was a positive year for inflation linked securities (ILS). The MBono (nominal) bond benchmark yielded -0.55% with a risk (standard deviation of returns) of 5.79%, while Udibonos (ILS) benchmark yielded 8.57%, with a risk of 7.55%. The Sharpe ratio (a measure of efficiency of return vs. risk) of Udibonos (1.14) was higher than that of Mbonos (-0.84) (Figure 11).
Figure 11. PiP-Udibonos and PiP-MBonos: return-risk (2016-2017). Source: PiP
Rate forecasting: term premium One way of determining the market view for the economy and interest rates is the term premium. According to theory, when the market expects an economic slowdown, the term premium (differential between long and short term rates) falls. Between 2005-2016 (Figure 12) when term premiums (difference between 10 year bond rate less one day rate, or 30 year bond less one day rate) reached their minimum, or turned negative, the economy (measured as 12 month GDP growth) slowed, and once the figure was publicized term premiums began to return to more “normal” levels. Generally this occurs due to a rise in long term rates, a fall in short term rates, or both. Between 2008 and 2015 Banxico did not raise short term rates. Figure 12. Nominal rates: term premium (%) (31/Mar/2017). Source: PiP and Bloomberg
10Y-1D
30Y-1D
Quarterly GDP growth (YoY)
8.00
6.00 4.00 2.00
Jun/16
Jun/15
Dec/15
Dec/14
Jun/14
Dec/13
Jun/13
Dec/12
Jun/12
Dec/11
Jun/11
Jun/10
Dec/10
Dec/09
Jun/09
Jun/08
Dec/08
Dec/07
Jun/07
Dec/06
Jun/06
Dec/05
(2.00)
Dec/16
??
-
(4.00) (6.00) (8.00)
6
Monthly perspective
April 6, 2017
Currently the term premium for nominal rates is at its lowest level since 2013. Also, owing to the uncertainty induced Franklin Templeton Servicios de Asesoría Mexico by the Trump administration, an economic slowdown is expected in the first quarter of 2017. The same has occurred in the term premium for ILS (Figure 13). However, movements are less violent than with nominal rates. Figure 13. Real rates: term premium (%) (31/Mar/2017). Source: PiP and Bloomberg
30Y-5Y
Quarterly GDP growth (YoY)
8.00
6.00 4.00 2.00
Jun/16
??
Dec/16
Dec/15
Jun/15
Jun/14
Dec/14
Jun/13
Dec/13
Jun/12
Dec/12
Jun/11
Dec/11
Jun/10
Dec/10
Jun/09
Dec/09
Dec/08
Jun/08
Jun/07
Dec/07
Dec/06
Jun/06
(2.00)
Dec/05
-
(4.00) (6.00) (8.00)
We therefore consider it possible that once the GDP growth figure for 1Q2017 is revealed, there will be a rise in long term rates. Risks and opportunities for 2017 The year 2017 offers abnormal risks (see Monthly Perspective February 2017). The trade relationship between Mexico and the US is key, and all related news will continue to move markets. We think that this year could be positive for short term Mexican ILS for the following reasons: 1. Peso depreciation during 2016 has affected producer price inflation and historically this affects consumer price inflation. This only began to occur in recent months, and there is still a large gap between producer costs and consumer prices. 2. For passthrough to occur from producer to consumer prices, peso depreciation should be sustained, not temporary (e.g. that observed between the election and inauguration of Trump). We believe that the 2016 peso depreciation has not yet worked its way through to consumer inflation. 3. Even though Banxico has raised rates this year, the yield curve is still flat, which could imply a rise in long term rates. Conclusion We are in an environment of rising rates, at least in Mexico and the US. Furthermore we cannot rule out inflationary surprises in Mexico. Short term Mexican ILS are less sensitive to a rise in long term rates, and offer protection against inflation. Luis Gonzalí Editor: Timothy Heyman April 6, 2017
7
Monthly perspective
April 6, 2017
Main financial indicators: monthly and YTD performance (March 31, 2017) Franklin Templeton Servicios de Asesoría Mexico During March, in Mexico the IPC rose 3.60%. Short term nominal rates fell, and medium and long term nominal rates rose. Ten year real rates rose. The US$ weakened 6% against the peso. In the US the DJ and S&P500 fell, and NASDAQ rose. Real and nominal rates rose for all terms. The oil mix fell 7.43% and WTI 6.31%. In the Banxico business climate survey, optimism rose to 15% (12% previous), no change to 48% (24%), and pessimism fell to 36% (64%). Mexico Stock market and oil 31-Mar-17 IPC Local currency (USD/MXN) Mexican oil mix (USD/bl)
28-Feb-17
Month
YTD 2017
2016
48,541.56
46,856.79
3.60%
6.35%
6.20%
18.80
20.00
-6.00%
-8.85%
19.53%
42.6
46.02
-7.43%
-7.99%
69.16%
Nominal rates 31-Mar-17
28-Feb-17
Month
CETES 28
6.58%
6.25%
33 bps
YTD 2017 74 bps
2016 279 bps
CETES 360
6.70%
6.79%
-9 bps
27 bps
277 bps
M5
6.91%
7.13%
-22 bps
-30 bps
166 bps
M10
7.07%
7.46%
-39 bps
-43 bps
118 bps
M30
7.46%
7.90%
-44 bps
-36 bps
87 bps
Real rates 31-Mar-17
28-Feb-17
Month
UDIBONO 10
3.36%
3.35%
1 bps
YTD 2017 31 bps
2016 -29 bps
UDIBONO 30
3.63%
3.80%
-17 bps
-16 bps
-12 bps
31-Mar-17
28-Feb-17
Month
1,249.20
1,248.44
0.06%
7.85%
9.15%
50.6
54.01
-6.31%
-5.81%
41.97%
Commodities Gold WTI (USD/bl)
YTD 2017
2016
UMS 31-Mar-17
28-Feb-17
Month
UMS 10 years
3.85%
3.91%
-6 bps
YTD 2017 -42 bps
2016 40 bps
UMS 20 years
4.82%
4.99%
-17 bps
-45 bps
-3 bps
UMS 30 years
4.83%
4.99%
-16 bps
-43 bps
-3 bps
Stock markets (US$) 31-Mar-17
28-Feb-17
Month
MSCI Developed
7,328.14
7,245.76
1.14%
YTD 2017 6.53%
2016 8.15%
MSCI Emerging
2,040.90
1,990.16
2.55%
11.49%
11.60%
MSCI Mexico
9,382.59
8,543.74
9.82%
16.06%
-8.98%
MSCI Brazil
5,619.90
5,884.23
-4.49%
10.43%
66.75%
US Stock market 31-Mar-17
28-Feb-17
Month
20,663.22
20,812.24
-0.72%
4.56%
13.42%
S&P
2,362.72
2,363.64
-0.04%
5.53%
9.54%
Nasdaq
5,911.74
5,825.44
1.48%
9.82%
7.50%
DJ
YTD 2017
2016
Nominal rates 31-Mar-17
28-Feb-17
Month
Tbill 90
0.76%
0.53%
23 bps
YTD 2017 25 bps
2016 35 bps
Tnote 5
1.93%
1.89%
4 bps
0 bps
17 bps
Tnote 10
2.40%
2.36%
4 bps
-5 bps
18 bps
Tbond 30
3.02%
2.97%
5 bps
-4 bps
5 bps
Real rates 31-Mar-17
28-Feb-17
Month
Tip 5
0.16%
0.00%
16 bps
YTD 2017 7 bps
2016 -36 bps
Tip 10
0.43%
0.34%
9 bps
-7 bps
-23 bps
Tip 30
0.94%
0.87%
7 bps
-5 bps
-29 bps
Bank of Mexico survey Indicator
2017 2017 anterior
PIB
1.49%
1.49%
Inflation
5.56%
5.39%
Cetes 28
7.10%
7.20%
Local currency
20.15
21.15
Business conditions
31-Mar-17
28-Feb-17
Optimism
15%
12%
No change
48%
24%
Pessimism
36%
64%
Source: Bloomberg, Banco de Mexico
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Monthly perspective IMPORTANT LEGAL INFORMATION
April 6, 2017 Franklin Templeton Servicios de Asesoría Mexico
The material has been prepared by Franklin Templeton Servicios de Asesoría México, S. de R.L. de C.V. (“FTSAM” or the “Company”) which has the folio inscription number 30045-001-(14127)-15/04/2016 in the Public Register of Investment Advisors assigned by the National Banking and Securities Commission (Comisión Nacional Bancaria y de Valores) in terms of the Securities Market Law (Ley del Mercado de Valores). Registry does not imply compliance with the regulations applicable to the services that are provided, nor the precision or veracity of the information provided. The content of this document is for information purposes only. Past Performance is not a guarantee of future returns. The material has been prepared by FTSAM solely for use in this document, and is intended to be of general interest only and does not constitute legal or tax advice nor is it an offer for shares or invitation to apply for shares of any kind. Nothing in this document should be construed as investment advice. This document may contain information obtained from various sources, and while it may be considered reliable, the Company makes no warranty or any statement on its fidelity, accuracy, scope or coverage, as the Company has not verified, validated or audited independently such information. The information is partial and, therefore, cannot be called complete. You agree to keep the contents of this document strictly private and confidential and it shall not be disclosed, copied, reproduced or redistributed (in whole or in part) to any person without the prior written consent of the Company. This document may contain "forward looking statements" and results may vary from those expressed or implied are included in this document. Such forward-looking statements can be identified, among other words, by the use of terminology such as "expect", "anticipate", "believe", "continue", "could", "estimate", "predict", "try" "plan", "predict", "should" or other forward-looking terminology, or by the negative of these words or comparable terminology, including without limitation the plural form of these words. All forward-looking statements relate to the Company's current expectation regarding future events and are subject to a number of factors that could cause actual results to differ materially from those in respect of the forward-looking statements. One must be cautious of such statements and should not place undue reliance on any forward-looking statements. This document includes no representation or warranty (express or implied) so it should not support the accuracy, fairness or completeness of the information presented or contained in this document. Neither the Company nor any of its affiliates, employees, advisers or representatives accepts any liability for any loss or damage caused by the information presented or contained in this document. The information presented or contained in this document is current as of the date indicated and is subject to change without notice and its accuracy is not guaranteed. The information contained herein and the views, if any, expressed therein are issued on the date hereof and, therefore, are conditioned and / or subject to probable changes due to changes in applicable law, as well as the conditions and circumstances that may or may not be provided in this document, in addition to over time and other similar situations. Neither the Company, nor its affiliates, agents, employees nor advisers assume any responsibility or obligation to inform you or any other person regarding any changes to the information or opinions expressed herein resulting from matters, circumstances or events that may arise in the future or that may be brought to our attention after the date herein. This document should not be construed as legal, tax, investment or any other type of advice. This document does not constitute an offer or invitation to purchase or subscribe shares or other securities and no part of this document or any information, opinion or statement contained herein shall be the basis of, or be referred to in connection with any contract or commitment. Any decision to purchase securities in any offering of securities should be made solely on the basis of information contained in the prospectus of the securities offered. By reading this document, you agree to be subject to the above limitations. Copyright © 2017. Franklin Templeton Investments. All rights reserved. Valid only in the United States of Mexico.
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