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Conclusion: We continue to receive official confirmation of our longstanding call that inflation will surprise to the upside in Brazil, leaving a path of slower growth and higher interest rates in its wake. Further, we’re flagging the potential for structural inflation to take hold in Brazil – an outcome that would have negative consequences for the region at large.


Conclusion: Bearish on Brazilian Equities and real-denominated debt for the intermediate-term TREND. Bullish on Brazil’s inflation-linked bonds for the intermediate-term TREND.

This morning, we got a plethora of very sobering news regarding the slope and trajectory of inflation within Brazil (higher, in both cases). Both are going in the wrong direction for holders of Brazilian equities or real-denominated fixed income assets. Holders of Brazil’s inflation-linked bonds should continue to cheer on these developments, however.

As Dilma Rousseff (Brazil’s Obama), Alexandre Tombini (Brazil’s Bernanke), and Guido Mantega (Brazil’s Geithner) talk down, up, and around inflation, respectively, we continue to receive confirmation of our call that inflation is a growing problem in Brazil – one that will surprise consensus expectations to the upside over the intermediate-term TREND. Consider the following takeaways from an Alexandre Tombini interview with famed Brazilian economic columnist, Miriam Leitao provided by our Portuguese-speaking Managing Director Moshe Silver: 

  • A major take-away was his statement that inflation over the coming 12 months may well exceed the current upper limit of the bank’s target range (+4.5% +/- 200bps);
  • Tombini said the uncontrolled influx of foreign capital – US$35 billion in the last three months alone – is undoing the central bank’s work to restrict credit; and
  • Tombini affirmed that there is no political interference with the bank’s programs, and reaffirmed that inflation would be returned to current target by the end of 2012. 

By the end of 2012??

As we pointed out in prior reports, Brazil’s political elite has become increasingly comfortable with higher rates of inflation over the near-to-intermediate term, opting instead to slow the pace and magnitude of rate increases in what we feel is a misguided attempt to preserve near-term economic growth.

As a point of reference, consensus for Brazil’s 2011 CPI YoY growth rate have been ripping to the upside as of late (lagging our early November call and alongside a subsequent (-12.7%) decline in the Bovespa Index). The latest 2011 Brazilian CPI forecasts are as follows: 

  • Bloomberg Consensus: +5.5%
  • Brazil Central Bank Economist Survey: 6.37% 

Brazil’s “High and Controlled” Inflation Rate - 1

By comparison, our proprietary models peg Brazilian CPI to average in a range of +6.42% YoY to +6.67% YoY throughout 2011 – with the balance of risks skewed to the upside, given that Rousseff and Mantega appear to have successfully halted real appreciation for the time being through a series of newly implemented foreign capital controls and levies dating back to October.

The real is down (-2.6%) in a straight line vs. the US Dollar since it peaked on April 26 – the largest decline of any currency internationally vs. the USD over that duration. As we outlined in a couple of reports back in March, we expect Brazilian CPI to continue making higher-highs on top of our own street-high current estimates. Make no mistake, the confluence of recent policies designed to curb real appreciation may eventually become the final nail in the coffin with regard to Brazil’s current bout with The Stagflation.

“We’ve Got It Under Control,” Says Mantega

As central bank chief Tombini talks up Brazilian inflation towards Hedgeye estimates, Finance Minister Guido Mantega – Brazil’s equivalent of Tim Geithner – basically affirmed that neither he, nor the central government of Brazil have any idea what they’re doing to address it. His quotes are “Youtube-able”, and rather than attempt to paraphrase them, we’ll just paste Moshe’s translated notes below. We’re certain you’ll arrive at a similar conclusion as our own: 

  • In public testimony before the senate economic affairs committee, Mantega said Brazil is experiencing a new form of inflation that has never been studied in economic literature: “high and controlled.” He said the consumer price index could rise to 6% this year, but that would not be out of control. Rather than try to guide inflation back to the 4.5% midpoint – the original “inflation targeting” policy that Tombini executed for many years as a senior official at the central bank – Mantega says the objective now is for inflation to not exceed the 6.5% ceiling of the target range.
  • Mantega, speaking before the Senate, said he is comfortable with 6% inflation for 2011. Mantega articulated a significant shift in the government’s approach, saying he is comfortable with inflation at the upper end of the central bank’s target range (6%-6.5% ceiling) rather than trying to hold inflation to the midpoint of the range (4.5%), which has always been the “inflation targeting” policy.
  • Mantega blames current inflation on an “outbreak of inflation in developing nations,” saying producers fell asleep at the switch and “didn’t realize that there were countries where people were eating more, causing an increase in food consumption.” Mantega also blamed meteorological conditions and financial speculators as causes for the rise in inflation.
  • Mantega says things aren’t so bad – after all, Brazil’s inflation is still below Russia’s (9.4%) and India’s (8.8%). But Brazil has other issues, including that many contracts are inflation indexed, meaning the cost of certain goods and services will automatically rise based on increases in reported CPI, creating a vicious cycle.
  • One Senator angrily told Mantega that inflation is a major concern for all Brazilians, especially now that the central banker has thrown in the towel and said it is no longer possible to control inflation for the rest of this year. The senator said Mantega was being Pollyannaish and refusing to confront reality. Mantega reportedly did not have any new ideas about reducing prices. 

The most important takeaways from his testimony are threefold: 

  • Brazil will experience a period of higher inflation, likely at or near the upper end of the central bank’s target range;
  • The Brazilian government will be relatively comfortable with this higher rate(s) of inflation and will likely have a muted policy response as a result of it being “controlled”; and
  • Brazilian officials, much like The Bernank and his Fed cronies, blame current higher rates of inflation on emerging market demand, the weather, and speculators in commodity markets. 

Apparently, it seems the entire developing world took a cue from Jackson Hole to eat more, drive more, work more, shop more, etc… We obviously disagree with that conclusion and reject it as another fallacy of the Keynesian Kingdom. The great 20th century economist Ludwig von Mises has our back on this one:

"The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy."

The net result of this marginally dovish stance out of the central bank and central government is that inflation has the potential to become a structural issue in Brazil as it once was many moons ago. Two factors that support this budding thesis is the fact that Brazil is highly susceptible to a price-wage spiral, given the left-leaning tendencies of the central government and its massive influence on big business in Brazil (see: Vale, Petrobras, BNDES loans to private firms). We anticipate that Rousseff will be quick to give in to worker demands for higher wages should inflation continue to do what we expect it will do. Additionally, financing needs for the 2014 World Cup, the 2016 Olympics, and a bevy  of infrastructure and energy investments will require a combination of public spending, BNDES loans, and foreign capital to the tune of roughly R$3.3 trillion (US $2.1T) over the next 3-5 years. Putting that in context, Brazil’s Gross Domestic Product is only US $2.02T (2010).

A shift on the margin towards incremental hawkishness and fiscal conservatism SOONER, rather than later, would be a very, very good thing for Brazil’s long-term economic prosperity. We’ll leave you and whomever from the Brazilian bureaucracy that is reading this note with the following quote from Milton Friedman:

"Inflation is a disease, a dangerous and sometimes fatal disease, a disease that if not checked in time can destroy a society."

Moshe Silver

Managing Director

Darius Dale


Brazil’s “High and Controlled” Inflation Rate - 2