Conclusion: While we remain bullish on the Brazilian Consumer sector for the long-term TAIL, the confluence of slowing growth and accelerating inflation remain a headwind over the intermediate-term TREND. As a result of inflationary pressures, we see additional tightening on the horizon in 1H11.
Over the past day or so, a couple of nasty economic data points have come out of Brazil:
- While certainly a stale number, 3Q10 GDP growth came in a full 250bps slower than 2Q10 at +6.7% YoY (after a +40bps revision to 2Q10). We expect growth to continue to slow over the next 3-6 months, a call aided by incredibly difficult comparisons starting in 4Q10 (+5% in 4Q09, +9.3% in 1Q10).
- CPI accelerated to a 21-month high in November, coming in at +5.63% YoY – well above the government’s 4.5% target. On a MoM basis, November’s +0.83% rise was the largest increase since April 2005! The largest contributor to the increase (0.51) was from the Food Products category, which rose +2.22% MoM.
Our call for Brazilian growth to continue slowing coupled with having already received two months of accelerating inflation readings for 4Q10 suggests Brazil’s economy could be in a state of marginal stagflation as early as… well… now:
From Brazil, to China, to India and elsewhere around the globe, we see that Chairman Bernanke’s experiment with Quantitative Guessing continues to have unintended consequences, due to the impact of the equation highlighted below:
QG = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]
The recent surge in Brazilian inflation from the August lows has had the Brazilian bond market anticipating rate hikes in the near future, with yields rallying to higher highs over the past three-plus months. In addition to the accelerating inflation readings, the locking-out of foreign investors from the bond market coupled with concerns that President-elect Dilma Rousseff will fail to curb spending and perpetuate inflation via loose fiscal policy has certainly had Brazilian bond investors demanding higher yields to hold government paper:
While not much has changed regarding inflation and the de facto blockade of international investors, we will give much-deserved credit to the current regime, as well as Rousseff and her team for taking meaningful steps to combat inflation and assuage investor fears of an inflationary tsunami of late.
On December 3rd, the central bank raised reserve requirements on cash and time deposits to slow consumer lending – the demand for which, coincidentally hit a record high in November, growing +20% YoY. The reserve requirement on time deposits rill rise to 20% from the current 15% and the requirement for cash deposits will rise to 12% from 8% currently. The measures are expected to remove R$61 billion ($36B) from the economy.
Rousseff’s choice to replace current central bank Governor Henrique Meirelles with Alexandre Tombini has been well-received by those calling for prudent monetary policy going forward. The 46-year old, who was just confirmed by the Senate, has served on the central bank board since 2005 and is credited with helping design the country’s inflation-targeting regime in 1999.
While Tombini sees eye-to-eye with his new boss on the need to lower Brazil’s G20-high real interest rates to spur long-term investment, the governor-in-waiting has repeatedly stressed the need for “full operating autonomy” to tackle any inflationary challenges along the way. Current trading in Brazil’s interest rate futures contracts suggest market practitioners are anticipating a +50bps rate hike when he takes over in January.
Elsewhere on the macro-prudential front, we have seen austere steps taken by Mrs. Rousseff and her team, which, on the margin, is a meaningful shift away from her campaign stance of maintaining continuity with current President Lula’s policies by continuing to spend more on social welfare programs.
For example, Finance Minister Guido Mantega has announced recently that there will be a “general cut” in expenditures during the Rousseff government, sparing only priority projects such as Bolsa Familia – Brazil’s highly-regarded transfer program. Even the beloved BNDES Bank will see its budget cut by ~50% next year. This is a major step toward combating inflation and toning down domestic demand, as the bank’s main role is to provide subsidized credit for long-term projects. BNDES’ lending rate has been kept at 6% since July 2009 – a full 475bps lower than the benchmark SELIC lending rate.
All told, we like the direction of Brazil’s fiscal and monetary policy; we do, however, caution that because Brazil has been slightly late with its response to inflationary pressures, quickening prices will likely remain a concern over the intermediate-term. As a result, we continue to anticipate rate hike(s) in 1H11, as the government looks to quash this headwind. The one caveat here would be that if growth comes in considerably slower in 1Q11, the ability of the Brazilian government to tighten in a way they perhaps should would likely be mitigated.
Let’s just hope for Brazil’s sake we don’t have to say, “I told you so.”