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Takeaway: For now at least, investors should stay SHORT, underweight, or completely out of Brazil.

CONCLUSIONS:

  1. Looking to Brazil specifically, we continue to see inflationary pressures emanating throughout the economy, which is perfectly in-line with view we introduced as part of our AUG ’11 Brazil Black Book, which called for Brazilian CPI to remain persistently elevated over the long-term TAIL.
  2. The aforementioned sticky inflation has weighed and continues to weigh on the slope of Brazilian economic growth.
  3. Jumping ship, two potential catalysts we see heading into and through 2H14 that investors will become increasingly focused on are the 2014 World Cup (6/12 – 7/13) and the 2014 General Elections (OCT 5).
  4. The former will obviously deliver a much-needed boost to GDP (positive catalyst), but might also expose Brazil’s shoddy infrastructure, ill-preparedness to host such a large event and angry populous (riots?) to the world stage (negative catalysts). The latter might ultimately be viewed as a positive catalyst if the market starts to price in expectations for a candidate like Jose Serra emerging victorious with Pena Nieto-like promises of economic reforms.
  5. For now at least, investors should stay SHORT, underweight, or completely out of Brazil.

WHERE WE’VE BEEN

In a unanimous 8-0 decision yesterday afternoon, BCB hiked its benchmark SELIC Rate by another +50bps to 10.5%. This tightening measure marked the sixth consecutive meeting where BCB hiked interest rates; the SELIC rate has now been hiked +325bps from an ill-advised (but forced) record-low of 7.25% in APR ’13, making BCB the most hawkish central bank in the world over that time frame.

We were very critical of President Rousseff and Finance Minister Guido Mantega’s overt influence over Brazilian monetary policy then (dating back to JUL ’12) and that policy interference continues to haunt the Brazilian economy to this day. From the analytical rooftops, we boldly shouted “GET OUT OF BRAZIL IF YOU HAVEN’T ALREADY” in early FEB ’13 as a continuation of this thesis:

“Not much else needs to be said other than the fact that it has recently become clear to us that Brazilian policymakers refuse to address the country’s growth/inflation imbalance – which they themselves have perpetuated through currency debasement – with an adequate amount of exchange rate appreciation (we already know Dilma won’t budge on rates). As such, we no longer consider Brazilian equities or the BRL good investment opportunities on the long side with respect to the TREND duration…” (2/6/13)

Since then, both the Bovespa Index and the BRL are down roughly -16%; Bloomberg’s Brazil LC Sovereign Debt Index has declined -2.3% over that duration.

In full disclosure, we made a terrible mistake pitching Brazilian consumer exposure from early-MAY to mid-AUG of last year in an attempt to help investors find opportunities on the long side in the context of our bearish #EmergingOutflows theme; the MSCI Brazil Consumer Discretionary and Consumer Staples indices declined -17.5% and -10.7% over that time frame. Bad performance for a bad idea; we should’ve just stuck to the original script – something we have done since.

WHERE WE’RE GOING

Looking ahead, 1Y OIS rates are now trading at a +45bps premium to the benchmark SELIC rate after a +19bps DoD move, implying further hawkishness in the months ahead. Contrary to the general tone of sell-side commentary following yesterday’s hike, we think that is the appropriate view to adopt in the context of our #InflationAccelerating Q1 macro theme.

Looking to Brazil specifically, we continue to see inflationary pressures emanating throughout the economy, which is perfectly in-line with view we introduced as part of our AUG ’11 Brazil Black Book, which called for Brazilian CPI to remain persistently elevated over the long-term TAIL.

A bloated budget balance – which doesn’t include all of the accounting gimmickry Mantega pulls with BNDES – and an increasingly tight labor market remain headwinds for BCB’s inflation fight.

#INFLATIONACCELERATING: ALL EYES ON BRAZIL - Budget Balance

#INFLATIONACCELERATING: ALL EYES ON BRAZIL - Current Account

#INFLATIONACCELERATING: ALL EYES ON BRAZIL - Unemployment Rate

#INFLATIONACCELERATING: ALL EYES ON BRAZIL - Wages

Cyclically speaking, CPI accelerated on both a YoY and MoM basis in DEC; the YoY reading of +5.9% YoY remains ~140bps higher than the midpoint of BCB’s +4.5% +/- 200bps target and the MoM reading of +0.92% was the fastest sequential rate since APR ’03. Increasingly easy comps and a currency/commodity base effect (refer to slides 7-9 of our Q1 macro themes for more details) support maintaining a hawkish outlook for Brazilian CPI over the intermediate term.

#INFLATIONACCELERATING: ALL EYES ON BRAZIL - CPI MoM

#INFLATIONACCELERATING: ALL EYES ON BRAZIL - CPI Comps

In short, sticky inflation has weighed and continues to weigh on the slope of Brazilian economic growth.

#INFLATIONACCELERATING: ALL EYES ON BRAZIL - Business Confidence

#INFLATIONACCELERATING: ALL EYES ON BRAZIL - Industrial Production

#INFLATIONACCELERATING: ALL EYES ON BRAZIL - Consumer Confidence

#INFLATIONACCELERATING: ALL EYES ON BRAZIL - Retail Sales

WHAT MIGHT HAPPEN

Lastly, two potential catalysts we see heading into and through 2H14 that investors will become increasingly focused on are the 2014 World Cup (6/12 – 7/13) and the 2014 General Elections (OCT 5).

The former will obviously deliver a much-needed boost to GDP (positive catalyst), but might also expose Brazil’s shoddy infrastructure, ill-preparedness to host such a large event and angry populous (riots?) to the world stage (negative catalysts). The latter might ultimately be viewed as a positive catalyst if the market starts to price in expectations for a candidate like Jose Serra emerging victorious with Pena Nieto-like promises of economic reforms.

We’ll see.

For now at least, stay SHORT, underweight, or completely out of Brazil. If you have on existing SHORT positions, don’t add to positions unless you see lower-lows in the Bovespa Index (cycle trough: 45,044 on 7/3) and higher-highs in the USD/BRL cross (cycle peak: 2.4543 on 8/21/13).

Darius Dale

Associate: Macro Team