Macro Vision June 13, 2017

Transcription

1 Macro Vision June 13, 2017 Country risk: how far can it reach? The global environment has been favorable to emerging markets, despite the recent drop in commodity prices. Better global growth and lower external risks have been reflected in more benign asset prices over the past year. Foreign investors risk perception, as measured by the CDS (credit default swap), has declined in several emerging economies. In Brazil, it was no different: the country-risk premium fell from 500 bps in January 2016 to a level close to 250 bps in June this year. In addition to the benign evolution of the international scenario, the probability of approval of reforms, especially in the fiscal area, played a key role in explaining this movement. Maintaining the Brazilian risk premium at lower levels requires the continuity of the reforms, as well as a continuing benign international scenario. The benign international scenario has led to an increased risk appetite from foreign investors, despite the recent correction in commodity prices. Global indicators remain favorable, with growth in the U.S. and Europe surprising positively. Risks, in turn, seem contained. China s economic slowdown in the second half of the year will probably be gradual and not impact global markets significantly as it did in the period. This is because the economy is now at in more comfortable cyclical position, with a more balanced housing sector (low inventories and sales surpassing new construction), exports trending upward and the decrease in public investment being offset by the recovery in the private sector. In the U.S., the protectionist agenda appears to have lost steam. Finally, in Europe, the political landscape seems more symmetrical. The risk of a Europopulist government still seems high in Italy, but has been avoided in France, which, along with Germany, will likely reinforce its support for the Eurozone even in Italy, Eurosceptic candidates performed poorly in recent regional elections. As a result, emerging economies assets performed well over the past year. Country risk premium (as measured by CDS 1 ) has retreated and currencies have appreciated against the dollar. Brazilian assets have shown a similar behavior. Between January 2016 and June 2017, country risk as measured by CDS fell by almost half, reaching levels close to 200 bps in early May. The Brazilian currency strengthened, appreciating from 4.00 reais per dollar in early 2016 to close to 3.25 reais per dollar in May The CDS (credit default swap) is a bilateral contract that allows an investor to purchase protection against a credit event of the issuer of a particular asset. The greater the likelihood of an issuer s credit event (default), the higher the CDS premium, which serves as a measure of the respective entity s credit risk. Please refer to the last page of this report for important disclosures, analyst and additional information. Itaú Unibanco or its subsidiaries may do or seek to do business with companies covered in this research report. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the single factor in making their investment decision.

2 5-year CDS Macro Vision June 13, More appreciated emerging market currencies than in the beginning of 2016 Index number: jan/2016 = 100 Latin America Asia Central Europe and Africa 90 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 4,20 4,00 3,80 3,60 3,40 3,20 Lower country risk premium and more appreciated BRL BRL (lhs.) CDS (rhs) , Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 We show below that the drop in Brazil risk premium is due both to the more benign international scenario and to the probability of approval of reforms, which has increased over the past year. We have also mapped the interval within which the Brazilian CDS will likely fluctuate over the coming years, under different domestic and international scenarios. Comparing country risk premium with the sovereign rating We have collected the sovereign rating 2 (by Standard & Poor s) and the five-year CDS for 65 countries at three different points in time: early 2016, April 2016 and May Based on these data, we have built three curves that relate sovereign ratings to CDS S&P Rating vs. CDS May/2017 April/2016 January/ B- B B+ BB- BB BB+ BBB- S&P Rating Source: Bloomberg, S&P Ratings, Itaú Brazil: 5-year CDS Jan/16 CDS=500 Apr/16 CDS=350 May/17 CDS= Apr-15 Sep-15 Feb-16 Jul-16 Dec-16 May-17 Fonte: Bloomberg, Itaú 2 The sovereign rating is the rating assigned by a rating agency to a country issuing debt, according to the agency s assessment of that country s ability to honor its debt. Naturally, countries with lower ratings have higher CDS, as there is increased probability of an event of default. Page 2

3 Macro Vision June 13, 2017 Over time, the curve has shifted downward. Shifts of the curve as a whole indicate changes in the international scenario that uniformly affect all countries with the same rating. More specifically, downward shifts of the curve indicate a more benign international scenario. For example, countries with BB sovereign rating (Brazil s current rating) had an average CDS of 341 bps in January In May 2017, the CDS of countries with the same BB rating was, on average, 150 bps lower than that level in January 2016 (at 186 bps). The improvement in the international scenario is also seen when we compare the VIX volatility index at the three different points in time. In January 2016, this index was around 25 points, having decreased to 15 points in April 2016 and then reached levels close to historical lows in May 2017 (10 points). In addition to the international improvement, the probability of approval of reforms played a fundamental role in the drop of the Brazilian CDS. In January 2016, Brazil risk premium was approximately 500 bps, which indicates that, at market prices, Brazil was seen as a B+ country. By April 2016, if the risk perception had only dropped in line with the international scenario, Brazil's CDS would probably be around 420 bps. However, at that moment, the country risk was at 350 bps, indicating that, at market prices, Brazil was already seen as a better rating country (BB-). A similar behavior was observed in May 2017: the Brazilian CDS, around 200 bps, indicated that at market prices, Brazil was already seen as a BB country. Curve shifts indicate an improvement in the international scenario. Shifts along the curve, on the other hand, indicate idiosyncratic improvement in the perception of country risk. We may conclude that, between January 2016 and May 2017, in addition to the more benign outlook for emerging countries, the probability of approval of reforms contributed to a drop in Brazil risk premium. How far can the Brazilian CDS reach? We start from the equation below, in which Brazil s country risk is only a function of the average CDS of other 21 countries. The other countries CDS is a proxy for the international factors, while the domestic factors are represented by the error (ε) of the regression (i.e., everything that is not explained by international factors). Brazilian CDS = α 1 + α 2. other countries CDS + ε The following charts show the Z-score of the evolution of the international (other countries CDS) and domestic (ε) factors 3 ; i.e., at each point in time, the Z-score represents the number of standard deviations (s.d.) by which each of the indicators is above (+) or below (-) the historical average International factors 2008 Crisis Z-score of the CDS of other countries Domestic factors 3.00 Z-score of the model error Investment grade We have calculated the Z-score of the log of the international and domestic factors series; i.e., we have subtracted the historical average and divided by the historical standard deviation. Page 3

4 International factors Macro Vision June 13, 2017 A few interesting points arise from these charts: Regarding international factors, it should be noted that: There was a pattern change between the 2008 pre-crisis and post-crisis periods. Up to the crisis, the Z-score of international factors remained in negative territory, which indicates that, during this period, the external scenario was more benign than the average of the sample period. It is worth remembering that, between 2005 and 2007, average global growth reached 5% and public indebtedness was much lower (around 65% of GDP). After the crisis, there was a clear change in this trend: the Z-score of international factors began to fluctuate in positive territory, indicating a less-benign international scenario compared to the average of the sample period, in line with the scenario of lower global growth and larger public debts. In the most recent period ( ), the index has remained between 0 and 0.5 s.d. above the historical average. At the margin, however, the international scenario is at its most benign point in the post-crisis period. That is, the Z-score of international factors is close to zero (close to the historical average). Regarding domestic factors, it should be noted that: The Z-score of domestic factors remained below zero only while Brazil held the investment grade rating. That is, Brazil's country-risk premium remained below the historical average only during this period. After the loss of the investment-grade rating, the index has remained between 0 and 1 s.d. above the historical average. More specifically, over the past year, the probability of approval of reforms has led the Z-score of domestic factors from one to close to zero. Based on this information, we have built the table below, which shows the Brazilian 5-year CDS that would be compatible with different external and domestic scenarios. We have restricted the domestic and international factors to the recent fluctuation range. In the first case, from 0 to 1 s.d. in relation to the historical average, and in the second, from 0 to 0.5 s.d. in relation to the historical average. 5-year Brazil CDS compatible with different scenarios Domestic factors 0.00 s.d s.d s.d s.d s.d s.d s.d s.d s.d At the international level, we believe that the scenario will likely remain benign ahead that is, close to the historical average (0 s.d.) or slightly worse ( s.d.). Global growth will probably remain robust, being only partially offset by the withdrawal of monetary stimuli in developed economies. In the domestic scenario, the 0 to 1 s.d. interval in relation to the historical average reflects the probability of progress in the reforms; zero being the case in which the reforms advance in a similar way to that proposed to Congress, and one being the opposite case. This inference is based on the evolution of the domestic scenario over the past year, as described in the table below. Page 4

5 Macro Vision June 13, 2017 Domestic factor Domestic scenario description High after losing investment grade D.P. Without prospect of reforms Low after losing investment grade D.P. Reforms advancing Thus, the analysis of domestic and international factors leads us to believe that the Brazilian CDS can fluctuate between 175 bps and 400 bps. More than the external scenario, it will be crucial to understanding how the political landscape will affect the reforms, especially in the fiscal area, in order to determine the country risk level over the coming years. Conclusion Brazil's country risk, as measured by the 5-year CDS, fell more than 250 bps within a year and a half. In addition to the more favorable global environment, which led to a reduction in the risk premium of different economies around the world, the benign evolution of the domestic scenario, with a greater probability of approval of reforms that help stabilize public debt, was fundamental. Looking ahead, the continuity of the reforms, as well as the continuation of the benign international scenario for risky assets, will be crucial for the maintenance of country risk at low levels. Julia Gottlieb Macro Research Itaú Mario Mesquita Chief Economist Tel: Click here to visit our digital research library. Page 5

6 Macro Vision June 13, 2017 Relevant Information 1. This report has been prepared and issued by the Macro Research Department of Banco Itaú Unibanco S.A. ( Itaú Unibanco ). This report is not a product of the Equity Research Department of Itaú Unibanco or Itaú Corretora de Valores S.A. and should not be construed as a research report ( relatório de análise ) for the purposes of the article 1 of the CVM Instruction NR. 483, dated July 06, This report aims at providing macroeconomics information, and does not constitute, and should not be construed as an offer to buy or sell, or a solicitation of an offer to buy or sell any financial instrument, or to participate in any particular trading strategy in any jurisdiction. The information herein is believed to be reliable as of the date on which this report was issued and has been obtained from public sources believed to be reliable. Itaú Unibanco Group does not make any express or implied representation or warranty as to the completeness, reliability or accuracy of such information, nor does this report intend to be a complete statement or summary of the markets or developments referred to herein. Opinions, estimates, and projections expressed herein constitute the current judgment of the analyst responsible for the substance of this report as of the date on which it was issued and are, therefore, subject to change without notice. Itaú Unibanco Group has no obligation to update, modify or amend this report and inform the reader accordingly. 3. The analyst responsible for the production of this report, whose name is highlighted in bold, hereby certifies that the views expressed herein accurately and exclusively reflect his or her personal views and opinions and were prepared independently and autonomously, including from Itaú Unibanco, Itaú Corretora de Valores S.A. and other group companies. 4. This report may not be reproduced or redistributed to any other person, in whole or in part, for any purpose, without the prior written consent of Itaú Unibanco. Additional information on the financial instruments discussed in this report is available upon request. Itaú Unibanco and/or any other group companies is not, and will not be liable for any investment decisions (or otherwise) based on the information provided herein. Additional Note to reports distributed in: (i) U.K. and Europe: The sole purpose of this material is to provide information only, and it does not constitute or should be construed as a proposal or request to enter into any financial instrument or to participate in any specific business strategy. The financial instruments discussed in this material may not be suitable for all investors, and are directed solely at Eligible Counterparties and Professionals as defined by the Financial Conduct Authority. This material does not take into consideration the objectives, financial situation or specific needs of any particular client. Clients must obtain financial, tax, legal, accounting, economic, credit and market advice on an individual basis, based on their personal characteristics and objectives, prior to making any decision based on the information contained herein. By accessing the material, you confirm that you are aware of the laws in your jurisdiction relating to the provision and sale of financial service products. You acknowledge that this material contains proprietary information and you agree to keep this information confidential. Itau BBA International plc (IBBAInt) exempts itself from any liability for any losses, whether direct or indirect, which may arise from the use of this material, from its content and is under no obligation to update the information contained in this document. Additionally, you confirm that you understand the risks related to the financial instruments discussed in this material. Due to international regulations not all financial instruments/services may be available to all clients. You should be aware of and observe any such restrictions when considering a potential investment decision. Past performance and forecast are not a reliable indicator of future results. The information contained herein has been obtained from internal and external sources and is believed to be reliable as of the date in which this material was issued, however IBBAInt does not make any representation or warranty as to the completeness, reliability or accuracy of information obtained by third parties or public sources. Additional information relative to the financial products discussed in this material is available upon request. Itau BBA International plc registered office is 20th floor, 20 Primrose Street, London, United Kingdom, EC2A 2EW and is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority (FRN ) Itau BBA International plc Lisbon Branch is regulated by Banco de Portugal for the conduct of business. Itau BBA International plc has representative offices in France, Germany, Spain which are authorised to conduct limited activities and the business activities conducted are regulated by Banque de France, Bundesanstalt fur Finanzdienstleistungsaufsicht (BaFin), Banco de España respectively. For any queries please contact your relationship manager; (ii) U.S.A: Itau BBA USA Securities, Inc., a FINRA/SIPC member firm, is distributing this report and accepts responsibility for the content of this report. Any US investor receiving this report and wishing to effect any transaction in any security discussed herein should do so with Itau BBA USA Securities, Inc. at 767 Fifth Avenue, 50th Floor, New York, NY 10153; (iii) Asia: This report is distributed in Hong Kong and Japan by Itaú Asia Securities Limited, which is licensed in Hong Kong by the Securities and Futures Commission for Type 1 (dealing in securities) regulated activity. Itaú Asia Securities Limited accepts all regulatory responsibility for the content of this report. In Hong Kong, any investors wishing to purchase or otherwise deal in the securities covered in this report should contact Itaú Asia Securities Limited at 29th Floor, Two IFC, 8 Finance Street Central, Hong Kong; (iv) Middle East: This report is distributed by Itau Middle East Limited. Itau Middle East Limited is regulated by the Dubai Financial Services Authority and is located at Suite 305, Level 3, Al Fattan Currency House, Dubai International Financial Centre, PO Box , Dubai, United Arab Emirates. This material is intended only for Professional Clients (as defined by the DFSA Conduct of Business module) no other persons should act upon it; (v) Brazil: Itaú Corretora de Valores S.A., a subsidiary of Itaú Unibanco S.A authorized by the Central Bank of Brazil and approved by the Securities and Exchange Commission of Brazil, is distributing this report. If necessary, contact the Client Service Center: * (capital and metropolitan areas) or (other locations) during business hours, from 9 a.m. to 8 p.m., Brasilia time. If you wish to re-evaluate the suggested solution, after utilizing such channels, please call Itaú s Corporate Complaints Office: (on business days from 9 a.m. to 6 p.m., Brasilia time) or write to Caixa Postal , São Paulo-SP, CEP * Cost of a local call. Page 6