FX, RATES & MACRO STRATEGY RESEARCH

Fixed Income & Economics Daily

Wednesday, June 15, 2016

FX & RATES STRATEGY RESEARCH David Duong

Marcin Sulewski*

212-407-0979 [email protected]

48 22-534-1884 [email protected]

•

BRAZIL: External drivers dominate risk assets; Details on government’s fiscal proposal today

•

POLAND: Currency and bonds under pressure

BRAZIL: External drivers dominate risk assets; Details on government’s fiscal proposal today

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Markets were heavily focused on external drivers, namely Brexit concerns, which seemed to dominate the effect of better US retail sales data in terms of pushing risk assets weaker yesterday. BRL performed better than LatAm peers, ending the NY trading day flat compared to a loss of -0.30% in the LACI Index. In rates, DI widened 3-7bps along the curve. Today we have the rate decision from the Fed with the market pricing in little possibility of a hike, but we believe markets will remain volatile and risk-off ahead of the Brexit vote on June 23.

•

•

POLAND: Currency and bonds under pressure

•

Tuesday was already the next day of the zloty’s significant depreciation and sharp jump of yields. EUR/PLN rose to 4.44 and USD/PLN to 3.96 (their highest since mid-May). Since Friday, the zloty has been the second weakest EM currency vs the EUR, USD, CHF and even GBP. At the same time, the 10Y yield skyrocketed above 3.25%, by 20bps within a week and the 5Y yield to 2.60%, higher by 32bps on a weekly basis. Even the 2Y benchmark yield rose 20bps since last Wednesday. As the 10Y Bund continued to gain, the 10Y PL-DE bond spread widened significantly to nearly 330bps, the highest since 4Q12. Obviously, the main source of the negative pressure on Polish assets was generated by the global risk aversion fueled by polls showing rising support for the “leave” option in next week’s referendum in the UK.

•

In our view, in the short term only, the dovish outcome of the FOMC June meeting could prevent Polish currency and bonds from further weakening.

Today we expect the government to present details on how long it intends to constrain public spending and by how much, with several proposals being discussed, all intended to manage the size of the debt supply relative to GDP. Finance Minister Henrique Meirelles has indicated that spending growth will be limited to the previous year’s inflation rate but the exact details of the mechanism have not yet been revealed.

Weaker trend in household consumption 20%

20%

15%

10%

10%

0%

5%

-10%

0%

-20% -30%

-5% -10% -15% Jan 12

Retail sales came in line with expectations at 0.5% m/m or -6.7% y/y, though broad retail sales were worse than expected at -9.1% y/y compared to a median consensus forecast of -8.6%. The latter indicates the weak trend in household consumption remains, which is consistent with rising unemployment in the country.

Retail sales (NSA y/y)

-40%

Real average earnings (US$, RHS) Jul 12

Jan 13

Jul 13

Jan 14

Jul 14

Jan 15

Jul 15

Jan 16

-50%

Sources: Haver and Santander.

IMPORTANT DISCLOSURES/CERTIFICATIONS ARE ATTACHED. U.S. INVESTORS’ INQUIRIES SHOULD BE DIRECTED TO SANTANDER INVESTMENT SECURITIES INC. AT (212) 583-4629 / (212) 350-3918.

*Employed by a non-US affiliate of Santander Investment Securities Inc. and not registered/qualified as a research analyst under FINRA rules, and is not an associated person of the member firm, and, therefore, may not be subject to the FINRA Rule 2711 and Incorporated NYSE Rule 472 restrictions.

LATAM ECONOMICS BRAZIL – Fiscal Policy Match Point

Tatiana Pinheiro* [email protected] 5511-3012-5179

•

Throughout 2015, the government took efforts to reverse the fiscal trend; nonetheless, the structural primary deficit widened again in 2016, likely, due to expenditure acceleration.

•

Moreover, according to our 2016 and 2017 forecasts, the primary result (using IMF methodology to adjusted for cycles ) will remain in negative territory, indicating that regardless of potential short-term improvement (as forecast by consensus) in the fiscal trend, the central government will still run a stimulative fiscal policy.

•

The coefficient of the structural primary balance is negative and significant for both service and market inflation, indicating that, ceteris paribus, each 1% in structural primary above the neutral level could reduce service inflation deviation from the target inflation and market inflation deviation from the target inflation by ~0.5 percentage points.

•

However, we believe that the match point for service and market inflation will be served by the fiscal policy in the long term given the option of a slow fiscal policy adjustment, in our opinion. We foresee the structural primary running above at 1% above neutral level from 2018 onwards.

Introduction We believe that the government’s strategy is to tighten the fiscal policy despite its downward revision of the primary balance this year to a deficit of 2.75% of GDP, which maintains the structural primary result (adjusted for the economic cycle) on the lax side. If indeed there is fiscal tightening from 2017 onward — and we expect as such — then, in our opinion, this tightening will be crucial to the disinflationary process in the upcoming years. Nevertheless, we believe that the improvement in the primary result will not be sufficient to stabilize the public debt ratio to GDP throughout this period. In this piece, we present our estimate for structural primary result (using IMF methodology 1) and the potential impact of the fiscal scenario on inflation, in particular with respect to service and market price inflation. In our opinion, following this first round in disinflationary process trigged by the plunge in regulated price inflation, we could have another round of the disinflationary process to be trigged by a tightening fiscal stance.

Structural primary result The main reason to measure the structural primary result is to obtain a more accurate assessment of the fiscal stance. Hence, we choose the approach of discounting (1) one-off (non-recurring fiscal operations) revenue and expenditures; (2) factors not correlated with the business cycle; and (3) the effect of the output gap in the primary result. In this sense, the structural primary balance is an improvement in looking at the cyclically adjusted primary balance with respect to interpreting the fiscal result. In the Brazilian case, we do not see relevant factors not correlated with the business cycle to be discounted from revenues and/or expenditures. For instance, we did not consider the commodity super-cycle of 2003-08 (prior to the international credit crunch) as a factor not correlated with the business cycle because Brazil economy is driven by domestic consumption, the importance of tax charged on export goods is low for the total revenue.. There are, of course, exception to this rule: some regional governments in Brazil (Rio de Janeiro, Espírito Santo, Minas Gerais, Pernambuco, and Bahia, for example) collected taxes from the mining sector (i.e., commodities) represent a significant share of total revenue. However, because the regional government’s contribution to the total public sector primary result is minuscule compared to the contribution of the central government (e.g., the National Treasury, BCB and the General Regime of Social Security — RGPS) at about a 10/90 ratio, we discounted the one-off impact and the business cycle effect on revenue and expenditures in order to assess the actual fiscal stance. 1 Bornhorst F., Dobrescu G., Fedelino A., Gottschalk J., and Nakata T., When and how to adjust beyond the business cycle? A guide to Structure Fiscal Balances, April 2011. Fiscal Affairs Department, IMF. https://www.imf.org/external/pubs/ft/tnm/2011/tnm1102.pdf

Fixed Income & Economics Daily, June 15, 2016

2

In this exercise, we used the official estimate of the central government’s primary balance as calculated by the National Treasury monthly since January 1997 2 and constructed from data on federal revenue (taxes and other revenue) and expenditures, allowing for a more detailed view of fiscal accounts. However, these data series do not generally coincide with the monthly figures estimated by the Central Bank following the Public Sector Borrowing Requirements (PSBR) methodology, which is the metric for fiscal targets. We do this because, in our opinion, the average discrepancy between the two surveys has been about R$ 200million/year on average since 2000, which is sufficiently small to be disregarded. Moreover, contrary to PSBR methodology, the National Treasury also discloses its revenue, distinguishing between tax and non-tax revenue, and its expenditures, distinguishing between mandatory and non-mandatory. Regarding one-off discounts, on the revenue side, we discounted one-off dividends and concession payments, the amount of the sale of oil rights (Petrobras pre-salt production) in September 2010, and the tax amnesty program (REFIS) in NovemberDecember 2013. On the expenditure side, we discounted the amount deposited in the Brazilian Sovereign (BS) Fund in December 2008, the capitalization of Petrobras in September 2010, and the payment of fiscal maneuvers throughout 2015. Thus, we ended up with the official primary balance figure deducted from these accounts, in order to obtain the actual fiscal effort, chiefly in terms of the impacts on domestic demand (see chart below). Central Government Primary Balance (% of GDP) 4% 3% 2% 1% 0% -1% -2% jan/98 out/98 jul/99 abr/00 jan/01 out/01 jul/02 abr/03 jan/04 out/04 jul/05 abr/06 jan/07 out/07 jul/08 abr/09 jan/10 out/10 jul/11 abr/12 jan/13 out/13 jul/14 abr/15 jan/16

-3%

Adjusted primary balance (% GDP)

Effective primary balance % GDP

Sources: National Treasury and Santander estimates.

The difference between the series, which had been, on average, high between 1998 and 2002 (around 1.1% of GDP), declined significantly between 2003 and 2008 (to 0.6% of GDP), but shot up from 2010 onward reaching 1.2% of GDP. In 2014, the central government primary adjusted by one-off factors reached a deficit of 0.99% of GDP, instead the official effective primary balance was a deficit of 0.3% of GDP. With the same purpose, after the deduction of the one-off factors, we deducted the impact of the output gap in revenue and expenditures. In this way, we decompose the primary balance into two parts: (a) the fiscal response to changes in economic activity (the cyclical component); and (b) the fiscal result independent of the economic cycle (the structural balance).

Aggregated vs. Disaggregated Approach The aggregated approach computes the cyclically adjusted balance as a function of cyclically adjusted overall revenue (Ra) and cyclically adjusted expenditures (Ga). The cyclical adjusted revenue is obtained by adjusting revenue for the effect of the deviation of potential from the effective GDP growth (output gap), with the revenue elasticity defining the strength of the cyclical effect. For this purpose, we estimate a regression of the following equations:

In this approach, we ran a Generalized Method of Moments (GMM) model to measure the pass-through coefficient, controlling for endogeneity problems. In the equations above, we state (1) federal revenue ( ); (2) real GDP growth ( ); (3) potential GDP growth ( ), and (4) federal expenditures ( ). And then, is the revenue elasticity to GDP, and is the expenditure elasticity to GDP. 2

http://www.tesouro.fazenda.gov.br/en/central-government-primary-balance

Fixed Income & Economics Daily, June 15, 2016

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According to our model, the revenue elasticity to GDP growth is 1.44, which is in-line with the economic theory, and means that each percentage increase in the output gap generate a percentage change in revenue larger than 1. Regarding the cyclical adjusted expenditure, the expenditure elasticity to GDP is 0, which is also in-line with the economic theory. In general, expenditure is discretionary, with part of it being independent from the economic cycle (such as, health, education and security spending) and part of it being opposite to the economic cycle (such as, social assistance spending, which increases during economic slowdown/contraction, and decreases during economic heating). Structural Primary Balance (Aggregated Approach)

Structural Balance and Cyclical Component (% of GDP)

4%

4%

3%

3%

2%

2%

1%

1%

0%

0%

-1%

-1%

-2%

-1.13%

-2%

Structural primary balance (Aggregated Approach) % GDP

-1.19%

-3%

jan/03 set/03 mai/04 jan/05 set/05 mai/06 jan/07 set/07 mai/08 jan/09 set/09 mai/10 jan/11 set/11 mai/12 jan/13 set/13 mai/14 jan/15 set/15

dez/03 abr/04 ago/04 dez/04 abr/05 ago/05 dez/05 abr/06 ago/06 dez/06 abr/07 ago/07 dez/07 abr/08 ago/08 dez/08 abr/09 ago/09 dez/09 abr/10 ago/10 dez/10 abr/11 ago/11 dez/11 abr/12 ago/12 dez/12 abr/13 ago/13 dez/13 abr/14 ago/14 dez/14 abr/15 ago/15 dez/15 abr/16

-3%

Structural balance

Ciclical Component

Effective primary balance % GDP

Sources: National Treasury and Santander estimates.

According to our estimate, the structural primary balance shows that the fiscal trend change took place in the aftermath of 2008’s financial crisis. Up to 2008, the official primary result and structural run parallel to 2% of GDP, signaling an intention to maintain a fiscal tight stance. After that, the structural primary shifted down and was held close to zero up until December 2013, despite official primary surpluses registered in this period. And, again in 2014, structural primary was shifted down to deficit side, and so the official primary result, without the help from international scenario and less nonrecurring revenue. Throughout 2015, the fiscal effort to reverse the fiscal trend is clear; however, the structural primary deficit widened again in 2016, due to expenditure acceleration. The disaggregated approach computes the cyclical adjustment of individual revenue and expenditure categories. In our exercise, we adjusted revenue to the economic cycle and maintained expenditures with cyclical adjustments, because in Brazil almost 60% of spending is toward payroll and around 20% goes to current spending and social program spending, all largely independent of the business cycle, therefore not requiring adjustment. Tax collection, social security contribution, and indirect taxes were adjusted for the economic cycle. According to our estimate, tax collection elasticity to GDP is 1.9; social security contribution elasticity is 2.7 and indirect taxes elasticity is 1. Our estimate for elasticity coefficients were in-line with the coefficients estimate by Girouard and André (2005) for OECD countries, except social security contribution elasticity, which is higher (more than the double). A reasonable explanation is that during 2003-14 the share of formal jobs surpassed 60% of the total labor market, leading social security contribution growth to run far above GDP growth. According to this approach, also we observed the primary deficit reversing throughout 2015, and widening again in 2016, due expenditure acceleration. To sum, on the primary result, we still see it in the red through April 2016, no matter which methodology we choose. The effective primary result points to a deficit of 2.32% of GDP, while the adjusted primary result points to a deficit of 1.94% of GDP; the structural primary aggregated adjusted points to a deficit of 1.13% of GDP, and the structural primary disaggregated adjusted points to a deficit of 0.73% of GDP. The data series range used to estimate the elasticities in both approaches is from January 2003 to December 2015 (on a monthly basis).

Fixed Income & Economics Daily, June 15, 2016

4

Structural Primary Balance (Aggregated vs. Disaggregated Approach) (% of GDP) 4% 3% 2% 1% 0% -1% -2%

abr/15

dez/15

ago/14

abr/13

dez/13

ago/12

abr/11

dez/11

ago/10

abr/09

dez/09

ago/08

abr/07

dez/07

ago/06

abr/05

dez/05

dez/03

ago/04

-3%

Effective primary balance % GDP Structural primary balance (Aggregated Approach) % GDP Structural primary balance (Disaggregated Approach) % GDP

Sources: National Treasury and Santander estimate.

And, including our forecasts for the primary balance, nonrecurring revenue, payment of fiscal maneuvers and GDP growth trajectories this year and 2017, the primary result adjusted for cycles (using IMF methodology) will remain in negative territory, indicating that, regardless of the short-term improvement forecast by consensus regarding the fiscal trend, the central government will still run a stimulative fiscal policy. Based on our forecast for the primary result, we expect a primary surplus of 0.1% of GDP, which would be supported significantly by non-recurring revenue of 1% of GDP. With this, we forecast that the structural primary balance will become neutral rather than tightened at year-end 2017. Primary Balance Factors Breakdown (% of GDP) 2015 Primary Surplus Non Recurring revenues and expenditures Impact of the Economic Cycle Spending Growth

(1.9)

2015 Fiscal Package (remanant Effect) New Fiscal Package 2016 Primary Surplus Non Recurring revenues Impact of the Economic Cycle Spending Growth (structural reform) New Fiscal Package 2017 Primary Surplus

0.5 0.2 (2.3) 1.1 0.6 0.4 0.3 0.1

Sources: National Treasury and Santander estimates.

Structural and Adjusted Primary Balance Forecasts 4,0% 3,0% 2,0% 1,0% 0,0% -1,0% -2,0% -3,0%

jun/17

set/16

dez/15

jun/14

mar/15

set/13

dez/12

jun/11

mar/12

set/10

dez/09

jun/08

mar/09

set/07

dez/06

jun/05

mar/06

set/04

-4,0%

dez/03

1.6 (1.9) (0.8)

Adjusted primary balance (% GDP) Structural primary balance (Aggregated Approach) % GDP Effective primary balance % GDP

Sources: National Treasury and Santander estimates.

The cyclical component (impact of economic cycle) will have a positive contribution of 0.6 p.p. in 2017, according to our estimate and given our expectation of GDP growth at 2% (which is slight above our expectation of the current potential GDP growth). In the following three years, based on our forecast for GDP growth around 3%, we obtain an economic cycle contribution of around 0.8 p.p. per year to the primary balance that implies in a structural primary of 1% of GDP above the neutral level, taking into account our forecast for primary surplus at 2% of GDP. And, because of this we foresee the fiscal policy serving as a factor of inflation deceleration only from 2018 onward. The match point for service inflation For the exercise that measures the potential impact of the fiscal stance on inflation (service inflation), we choose to use the structural primary data series obtained by the aggregated approach, as it is a parsimonious approach and easier to forecast. In a simple historical comparison, both service inflation compared to structural primary result (fiscal policy) and service inflation deviation from the target are negatively correlated. The same is observed comparing the market inflation (deviation from the target) to the structural primary result. Based on this, we ran a Generalized Method of Moments (GMM) model to measure the impact of the structural primary balance on service inflation and to minimize endogeneity problems. We used the Fixed Income & Economics Daily, June 15, 2016

5

service-inflation deviation from the target, the structural primary balance (aggregated approach), controlling for real interest rate (ex ante), output gap and BRL variation. Also we run the same equation for market inflation. The coefficient of structural primary balance is negative and significant for both service and market inflation, indicating that, ceteris paribus, each 1% of structural primary surplus (i.e. above neutrality) could reduce service inflation deviation from the target and market inflation deviation from the target by of around 0.5 percentage points. In 12 months accumulated up to May, the service inflation deviation from the target was around 3 p.p., and the market inflation deviation from the target was around 4 p.p., while the structural primary was a deficit of 1.1% of GDP. All this math shows the distance that the fiscal policy would have to go in order to start helping the inflation trajectory. Market inflation and Fiscal policy Tradeoff 5.0

5.0

Servivce inflation deviation from target

Market inflation deviation from target

Service inflation and Fiscal policy Tradeoff

4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Structural primary balance (aggregated approach)

Sources: National Treasury and IBGE.

2.5

4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -1.5

-0.5 0.5 1.5 Structural primary balance (aggregated approach)

2.5

Sources: National Treasury and IBGE.

That said, we believe the match point for service and market inflation could be served by the fiscal policy. Given that, we note the current environment of recession, a tight monetary stance, BRL appreciation, and service inflation having slightly dropped (to 7.5% from 8%, or in terms of service inflation deviation from the target, to 2.9 p.p. from 3.4 p.p.), while market inflation remains unchanged at ~8% (or in terms of market inflation deviation around 4 p.p.) between December and last May. However, the bad news is that the fiscal policy helping inflation fall might happen in the long term, due to the option of a slow fiscal policy adjustment. Even assuming a better primary result in 2017, it will remain continue far from the primary surplus required to stabilize the public debt ratio to GDP, which we estimate at 2-3% of GDP, depending on the real GDP growth level and interest rate in the steady-state assumption (for further details, see our report, The Fiscal Maze III: Insurgent, published on October 28, 2015). And, it will not be sufficiently tightened to help curb service/market inflation to the target. In the short term, the economic recession and recent BRL appreciation remain as the only drivers that can be counted on to help lower inflation, in our view.

BRAZIL ECONOMICS Rebound in Retail Sales Tatiana Pinheiro*, Adriana Dupita*, Everton Gomes*, Luciano Sobral*, Matheus Rosignoli*, Rodolfo Margato* +5511-3012-5179 [email protected]

According to the Monthly Survey of Retail released yesterday, core retail sales increased 0.5% m/m in April, in-line with the market consensus and our forecast (+0.5% m/m and +0.7% m/m, respectively), partially offsetting the decrease of 0.9% m/m registered in the previous month. As expected, the expansion of supermarket sales showed the largest contribution to the overall result in the period. On the other hand, broad retail sales – which includes vehicles, motorcycles, auto parts and building materials – retreated 1.4% m/m in April, below our projection and the median market expectation (both -0.9% m/m), mainly due to the dismal performance of vehicle sales. Fixed Income & Economics Daily, June 15, 2016

6

In short, we believe that retail sales will remain weak in upcoming months. The further deterioration in labor market conditions – rising unemployment rate, higher labor informality, shrinkage of real wages – and high household debt corroborate this scenario. Nevertheless, it is worth noting that the falling trend of inflation and the expectation of a significant decline in real interest rates sustain our view that private consumption will post a gradual recovery in 2017. We expect core retail sales to grow 1.5% next year, following a contraction of 4.0% this year.

COLOMBIA ECONOMICS Demand-Side Data Shows a Big Drop in Investment Brendan Hurley 212-350-0733 [email protected]

Demand side GDP breakdown for the first quarter of 2016, in which the economy grew by 2.5% y/y, was released on Friday and showed that the main detractor from GDP growth was associated with a precipitous drop in the areas of government spending and fixed investment while household demand remained buoyant and the external sector contributed positively to growth. Household demand grew at 3.5% y/y, driven by 3.9% y/y increases in durable and semi-durable goods, while durable goods continued their slide, falling by 4.6% y/y after falling by 1.5% y/y on average in 2015. Headline growth of 3.5% y/y in household demand compares to 4% growth in 2015. Government demand accelerated by only 1.6% in the first quarter, decelerating markedly from the 2.8% y/y growth seen in 2015 and contributing only .28 percentage points to headline growth of 2.5% vs. contributing .5 percentage points in 2015. The real sour note however was fixed capital formation (investment), which dropped by 4.8% y/y in the first quarter on the back of large drops in the categories ‘Machines and Equipment’ and ‘Transportation Equipment’, which fell by 10% and 33% respectively vs. the first quarter of 2015. The drop in investment in these two categories, likely due in large degree to lower exploration and extraction activities in the mining sector, subtracted 2.26 percentage points from the headline GDP growth figure, and was only partially offset by 11.4% y/y growth in the ‘Construction and Buildings’ category of investment, which contributed .78 percentage points to the headline GDP growth of 2.5% y/y. On the external side, net exports contributed positively to GDP growth as imports declined by 1.5% y/y, after falling by 3.6% y/y in the fourth quarter of 2015. The result shows that the process of import substitution is starting to benefit the economy as the trade balance narrows somewhat. In general, the results from the demand side of the economy reflect the delayed effect of an easing capex cycle in the private sector, which was not able to be offset by investment in the sectors of the economy that are supported by public investment, namely building construction and civil works. While the slowdown in household and government consumption was expected, and we believe they can rebound throughout the remainder of the year, the large drop in investment presents downside risks to our 2.7% 2016 forecast and thus will have to be monitored closely. Internal Demand vs. GDP

Consumption vs. Investment 25%

GDP YoY

12%

Internal Demand YoY

Consumption

Investment

20%

10%

15%

8%

10%

6%

5%

4%

0%

2%

-5%

0%

-10%

Jun-15

Dec-13

Jun-12

Dec-10

Jun-09

Dec-07

Jun-06

Dec-04

Jun-03

Dec-01

Jan-16

Jul-14

Jan-13

Jul-11

Jan-10

Jul-08

Jan-07

Jul-05

Jan-04

Jul-02

Jan-01

Source: DANE, Santander. Fixed Income & Economics Daily, June 15, 2016

Jun-00

-2%

7

Demand Side GDP Results 1

GDP

2.7%

2

3.1%

2015 3

3.1%

4

3.4%

Year

3.1%

2016 1

2.5%

Internal Demand

4.7%

3.1%

4.1%

2.5%

3.6%

1.3%

Final Consumption

4.4%

3.7%

4.3%

3.3%

3.9%

3.2%

4.7% 4.3% 5.9% 10.5% 4.4% 2.2%

3.8% 3.9% 2.8% 2.4% 4.1% 2.3%

4.4% 4.6% 6.8% -7.0% 4.5% 3.1%

3.0% 3.7% 3.2% -11.9% 3.7% 3.8%

4.0% 4.1% 4.7% -1.5% 4.2% 2.8%

3.5% 3.9% 3.9% -4.6% 3.8% 1.6%

6.5%

0.6%

3.2%

0.4%

2.7%

-3.7%

7.4% -5.9% 0.7% 41.2% 2.2% 3.4% 1.4%

3.3% -2.8% -1.9% 6.0% 10.1% 6.4% 4.7%

0.4% 0.4% -0.3% 3.3% -8.2% 7.0% -3.8%

0.3% 2.9% -5.4% -5.2% 8.1% 4.2% 1.5%

2.8% -1.4% -1.7% 11.3% 3.0% 5.3% 1.0%

-4.8% -0.2% -10.1% -32.9% 11.4% 0.4% 1.4%

4.2% 11.7% -7.4%

0.4% 0.3% 0.1%

-4.8% 8.0% -12.7%

-2.1% -3.6% 1.4%

-0.6% 4.1% -4.7%

2.1% -1.5% 3.6%

2.7% 2.7%

3.1% 3.1%

3.1% 3.1%

3.4% 3.4%

3.1% 3.1%

2.5%

Households Non Durables Semi Durables Durables Services Government Capital Formation Fixed Capital Formation Agropecuario Machines and Equipment Transportation Equipment Construction and Buildings Civil Works Services Exports Imports Net

GDP Source: DANE, Santander.

Fixed Income & Economics Daily, June 15, 2016

8

LATAM ECONOMIC EVENTS CALENDAR Time (EDT)

Country

Indicator

Period

Prior

Consensus

Forecast

Units

Comment

Monday, June 13, 2016 2:00 PM

BZ

Trade Balance Weekly

12-Jun-16

813

BZ

Tax Collections

May

110,895

Millions

BZ

Formal Job Creation Total

May

-62,844.00

Absolute

Millions

CO

Vehicle Sales

Feb

21,317

Absolute

MX

Formal Job Creation Total

May

20.33

Thousands

8:00 AM

BZ

Retail Sales MoM

Apr

-0.90

0.10

0.70

% Change

8:00 AM

BZ

Retail Sales YoY

Apr

-5.70

-7.30

-6.90

% Change

8:00 AM

BZ

Retail Sales Broad MoM

Apr

-1.10

-0.60

0.20

Sa

8:00 AM

BZ

Retail Sales Broad YoY

Apr

-7.90

-9.70

-9.10

Real %

BZ

CNI Industrial Confidence

Jun

41.30

% Change

10:00 AM

MX

International Reserves Weekly

10-Jun-16

177,300

Million

Tuesday, June 14, 2016

Wednesday, June 15, 2016

11:30 AM

AR

City of Buenos Aires CPI YoY

May

40.50

AR

City of Buenos Aires CPI MoM

May

6.50

BZ

Currency Flows Weekly

BZ

Economic Activity MoM

Jul11-Jul12=100 Jul11-Jul12=100

0.00

0.00

Apr

-0.36

0.43

0.40

-4.45

-4.10

0 Ibc-Br

BZ

Economic Activity YoY

Apr

-6.31

PE

Economic Activity YoY

Apr

3.72

% Change

PE

Unemployment Rate

May

7.00

% Ratio

Ibc-Br

Thursday, June 16, 2016 7:30 AM

BZ

COPOM Monetary Policy Meeting Minutes

0.00

0.00

5:00 PM

CL

Overnight Rate Target

16-Jun-16

3.50

3.50

3:00 PM

CO

Retail Sales YoY

Apr

-2.90

3.50

% Change

3:00 PM

CO

Industrial Production YoY

Apr

1.40

6.30

% Change

0 3.50

%

Friday, June 17, 2016 CO

Consumer Confidence Index

May

-13.00

% Change

Sources: Bloomberg and Santander.

Fixed Income & Economics Daily, June 15, 2016

9

SWAPS & FX SWAPS Brazil - DI CDI

Chile - CLP/Camara

Last

1D

1W

1M

14.13

14.13

14.13

14.13

Camara

Mexico - TIIE

Last

1D

1W

1M

3.50

3.50

3.50

3.50

RATES CURVE SWP SPR 115

1D

1W

1M

TIIE

4.10

4.09

4.09

4.06

Jan-17

13.71

13.68

13.57

13.57

6M

3.56

3.56

3.55

3.60

6M

4.42

4.37

4.41

4.21

Jan-18

12.68

12.55

12.54

12.59

1y

3.64

3.64

3.64

3.67

1y

4.71

4.66

4.71

4.44

Jan-21

12.60

12.35

12.40

12.13

2y

3.71

3.72

3.73

3.76

2y

4.96

4.91

4.99

4.68

Jan-23

12.72

12.49

12.55

12.23

5y

4.07

4.09

4.13

4.08

5y

5.54

5.48

5.63

5.32

Jan-25

12.84

12.61

12.71

12.35

10y

4.50

4.52

4.56

4.52

10y

6.18

6.13

6.31

6.07

Jan-17/Jan-18

-103

-113

-103

-98

6M/1Y

8

8

9

7

6M/1Y

29

29

31

23

Jan-17/Jan-21

-111

-133

-117

-144

1Y/2Y

7

8

9

9

1Y/2Y

25

25

28

25

Jan-18/Jan-21

-8

-20

-14

-46

2Y/5Y

36

37

40

32

2Y/5Y

58

57

64

64

Jan-21/Jan-25

24

26

31

22

2Y/10Y

79

80

83

76

2Y/10Y

122

123

133

139

Jan-23/Jan-25

12

12

16

12

5Y/10Y

43

43

43

44

5Y/10Y

65

66

69

75

Jan. '17

2

4

7

5

2Y

-19

-16

-21

-7

2Y

11

12

13

3

Jan. '18

-1

1

0

1

5Y

-11

-11

-9

-12

5Y

9

11

11

2

Jan. '21

-22

-20

-18

-14

10Y

-6

-7

-3

2

10Y

19

22

28

26

FX CORRELATION MATRIX* BRL MXN CLP Variable 0.72 0.49 S&P 500 0.29 -0.05 -0.25 DXY Index -0.45 0.29 0.40 0.63 WTI price CDS 5Y -0.65 -0.82 -0.64 0.63 0.62 Commodities** 0.48

LatAm Currency Performance (Since Sep 2008) 120

Last

September 12, 2008 = 100

110

*6M trailing correlation of weekly returns.

105 100 95 90 85 80 75 70

BRL

65 60 Sep-08

COP 0.55 -0.27 0.56 -0.65 0.36

Sep-09

Sep-10

MXN

Sep-11

COP

CLP

Sep-12

Sep-13

Sep-14

Sep-15

ARS/USD BRL/USD CLP/USD COP/USD MXN/USD PEN/USD

LATAM CURRENCIES 1D 1W Spot 14.243 -0.29% -0.32% 0.27% -0.61% 3.549 669.93 -0.15% -0.46% 2955.0 -1.40% -0.72% -1.06% -2.72% 17.80 3.331 -0.01% -1.29%

1M 3.32% 2.11% 0.06% 3.68% -1.76% 0.58%

BRL/EUR MXN/EUR CLP/BRL COP/BRL MXN/BRL CLP/MXN COP/MXN

SELECTED CROSSES 0.39% -2.05% 4.077 -0.96% -4.10% 20.45 189.01 -0.56% -0.09% -1.70% -0.04% 832.6 5.014 -1.40% -2.05% 37.86 0.56% 1.24% 166.62 -0.36% 1.23%

1.20% -2.59% -1.93% 1.55% -3.75% 1.56% 5.41%

Sources: Bloomberg and Santander. **CRB index for BRL, WTI for MXN, copper for CLP, soybean for ARS, coffee for COP.

Fixed Income & Economics Daily, June 15, 2016

10

LOCAL MARKET BONDS & IMPLIED POLICY RATE CHANGES 14.75%

NOMINAL BONDS

BRAZIL

Last

1D

1W

1M

Duration

LTN Jul-16

14.16

14.16

14.13

14.13

0.0

LTN Jan-17

13.69

13.66

13.56

13.65

0.5

LTN Jan-18

12.71

12.61

12.58

12.77

1.4

NTN-F Jan-17

13.76

13.71

13.63

13.70

0.5

13.75% 13.25%

NTN-F Jan-18

12.67

12.56

12.54

12.73

1.3

12.75%

NTN-F Jan-19

12.40

12.21

12.28

12.35

2.0

NTN-F Jan-21

12.50

12.29

12.37

12.34

3.2

12.25%

NTN-F Jan-23

12.64

12.39

12.50

12.44

4.1

NTN-F Jan-25

12.69

12.47

12.59

12.53

4.9

11.75%

4.25%

MEXICO

Jun-16 6.25%

3.70

3.80

3.80

3.82

0.0

Dec-16 7.25%

4.22

4.10

4.16

3.95

0.5

Jun-17 5%

4.23

4.14

4.30

4.05

1.0

Dec-17 7.75%

4.17

4.12

4.23

4.08

1.4

Jun-18 4.75%

4.75

4.69

4.77

4.50

1.9

Dec-18 8.5%

4.94

4.88

4.94

4.73

2.2

Jun-20 8%

5.32

5.26

5.40

5.21

3.4

Jun-21 6.5%

5.53

5.45

5.61

5.41

4.2

Jun-22 6.5%

5.71

5.65

5.78

5.60

4.8

Dec-23 8%

5.89

5.84

5.97

5.76

5.6

Dec-24 10%

5.96

5.88

6.01

5.82

5.9

Mar-26 5.75%

6.08

6.00

6.13

Jun-27 7.5%

6.27

6.22

6.31

6.10

7.4

May-29 8.5%

6.48

6.40

6.49

6.26

8.0

May-31 7.75%

6.59

6.51

6.65

6.39

8.9

Nov-34 7.75%

6.71

6.66

6.75

6.52

9.9

Nov-36 10%

6.74

6.67

6.82

6.56

9.9

Nov-38 8.5%

6.80

6.74

6.85

6.63

10.6

Nov-42 7.75%

6.80

6.73

6.87

6.64

11.6

7.3

INFLATION LINKERS

Brazil Implied Selic Rate

14.25%

Jun-16

Sep-16

Mar-17

Jun-17

Sep-17

Chile Implied Camara Rate

4.00% 3.75% 3.50% 3.25%

4.75%

Jun-16

Dec-16

Jun-17

Dec-17

Jun-18

Dec-18

Mexico Implied TIIE Rate

4.50% 4.25% 4.00% 3.75% 3.50%

Jun-16

Sep-16

Dec-16

400

Real Yield

Dec-16

1D

1W

1M

Duration

NTN-B Aug-16

9.63

9.74

9.60

9.01

0.2

NTN-B Aug-18

5.96

6.03

6.18

6.02

1.9

NTN-B May-19

5.95

5.96

6.07

6.05

2.5

250

NTN-B Aug-20

6.03

6.00

6.15

6.11

3.5

200

NTN-B Aug-30

6.04

6.01

6.11

5.97

9.0

NTN-B Aug-40

6.11

6.06

6.12

5.98

12.1

NTN-B Aug-50

6.16

6.10

6.17

6.06

13.7

100

UDIBONO 3Y

1.92

1.87

2.10

2.23

2.8

MEXICO

50

UDIBONO 10Y

3.05

2.95

3.08

3.05

7.7

UDIBONO 20Y

3.62

3.54

3.64

3.54

13.2

UDIBONO 30Y

3.76

3.70

3.82

3.68

17.6

-50

CHILE

UF 5Y

1.18

1.20

1.18

1.22

4.5

UF 10Y

1.53

1.56

1.57

1.48

8.9

-100

BRAZIL

Last

350 300

Mar-17

Jun-17

Sep-17

Dec-17

Mar-18

Jun-18

Spread between 1Y/1Y fwd and 1Y* Chile Mexico Brazil Colombia

150

0

Sources: Bloomberg and Santander. * Implied Banxico rates derived from the 28-day TIIE futures minus the historical spread between 28-day TIIE and Banxico O/N rate.

Fixed Income & Economics Daily, June 15, 2016

11

LATIN AMERICA MACRO STRATEGY RESEARCH CONTACTS / IMPORTANT DISCLOSURES Macro Research Maciej Reluga* Sergio Galván* Maurício Molan* Juan Pablo Cabrera* Brendan Hurley David Franco* Tatiana Pinheiro* Piotr Bielski* Marcela Bensión*

Head Macro, Rates & FX Strategy – CEE Economist – Argentina Economist – Brazil Economist – Chile Economist - Colombia Economist – Mexico Economist – Peru Economist – Poland Economist – Uruguay

[email protected] [email protected] [email protected] [email protected] [email protected] [email protected] [email protected] [email protected] [email protected]

48-22-534-1888 54-11-4341-1728 5511-3012-5724 562-2320-3778 212-350-0733 5255 5269-1932 5511-3012-5179 48-22-534-1888 5982-1747-5537

Macro, Rates & FX Strategy – Brazil, Peru Macro, Rates & FX Strategy – Colombia, Mexico Chief Rates & FX Strategist – Chile Macro, Rates & FX Strategy - LatAm Head of Credit Research

[email protected] [email protected] [email protected] [email protected] [email protected]

212-407-0979 212-350-0733 562-2320-3778 4420-7756-6633 212-407-0978

Head LatAm Equity Research Head, Andean Head, Argentina Head, Brazil Head, Mexico

[email protected] [email protected] [email protected] [email protected] [email protected]

212-350-3991 212-407-0976 5411-4341-1564 5511-3012-5747 5255-5269-2264

Fixed Income Research David Duong Brendan Hurley Juan Pablo Cabrera* Nicolas Kohn* Aaron Holsberg

Equity Research Christian Audi Andres Soto Walter Chiarvesio* Valder Nogueira* Pedro Balcao Reis*

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