At a time of US and European banking stresses, the COP’s March performance is notable in revealing the currency’s latest reordering of sensitivities. Growing concerns over the global economic outlook continue to weigh on oil prices, which had another poor month, down 9% in March to date. However, such traditional correlations have done little to hurt short-term COP sentiment, a sign of a near-term reshuffling in the correlation hierarchy and the most recent example of its fluid relationships. While these breakdowns typically recouple eventually, near-term correlations are leaning more heavily on the direction of US core rates and, to a lesser extent, on global equity valuations. The downward correction in US yields, and the resultant US curve steepening, is moving back into the driver’s seat and likely remains a positive underpinning for the COP’s short-term outlook. That said, with the 10Y UST yield pullback encountering greater short-term support at the 200-day averages (at 3.49%), we see a growing risk that the COP’s rally starts to stall towards 4600, unless we see a deeper retracement lower in US yields towards 3.0%—a risk more likely to emerge in 2H23.

Local market developments have also taken a more positive turn and, we believe, have contributed to COP performance too. In recent weeks, more details of the Petro government’s National Development Plan, encompassing reform proposals across several key sectors, have come to light and, overall, have eased some market fears of a more radical policy shake-up. Negotiations both within Petro’s coalition and with the opposition have been difficult, with high-profile departures from his cabinet (e.g., Alejandro Gaviria from Education, among others), due to dissent from the government’s initial health proposals, coalition partners’ reservations about labor and pension changes, and pushback from the Council of State (a judiciary body) against Petro’s move to regulate electricity/water rates. All these developments suggest the growing likelihood of more dilution in the government’s reform agenda, as Petro’s net approval ratings have trended lower since he took office last year.

The evolution of pension reform negotiations remains important at this stage, given their potential impact on local markets. In our view, the current government proposal diverting three minimum wages (MW) of private pension contributions to a public system remains a particular concern, with the potential to significantly affect a key domestic investor. Finding a lower consensus for the contribution threshold (say, 2MW instead of 3MW) remains a material challenge for the pension sector but could be construed as a ‘win’ vs. more pessimistic expectations previously. Local currency yield spreads have eased from January wides but have yet to convincingly tighten beyond the 800bp lows set in February. We remain wary about the eventual longer-term fiscal cost of some of these proposals (including increased fiscal obligations from the expanded public pension coverage); though we would not be surprised to see concerns pushed aside for the time being, they could resurface as a drag on the COP in the medium term.

Publication date: March 28, 2023

Mike Moran
mike.moran@santander.us

Outlook

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