Colombia: Surprise rate cut could trigger underperformance - BBH

On Friday, the Colombian central bank, announced a rate cut of 25 basis points surprising markets that expected no rate cut. According to analysts from Brown Brother Harriman, this is a risky move in the current global environment. They see the Colombia peso likely under pressure amid soft fundamentals and an aggressive easing cycle. 

Key Quotes: 

“The economy continues to slow. GDP growth is forecast to accelerate modestly to around 2.5% in 2017 and 3% in 2018 from an estimated 2.1%% in 2016.  GDP rose 1.2% y/y in Q3.  This was weaker than expected and the slowest since Q2 2009.  As such, we see downside risks to the growth forecasts.”

“Price pressures are still easing, with CPI rising 6.0% y/y in November.  This was the lowest rate since October 2015 but still above the 2-4% target range.  PPI may be accelerating now, due in part to the weak peso.  As such, the central bank will have to be careful in managing this easing cycle.”

“Yet the central bank cut started the easing cycle with a 25 bp cut to 7.5% on Friday.  The last move was a 25 bp hike back in July.  Minutes from this meeting will be released December 30.  New Governor Echavarria will take over from Uribe next month, and is likely to be even more dovish given his close ties to President Santos.  The central bank is thus likely to continue the easing cycle then with another 25 bp cut.”  

“Our EM FX model shows the peso to have VERY WEAK fundamentals, so this year’s outperformance does not seem warranted.  Retracement objectives for the November-December drop in USD/COP come in near 3052 (38%), 3082 (50%), and 3111 (62%).”

“With inflation likely to continue falling and the central bank likely to continue cutting, we think Colombian bonds will continue outperforming.”