Aug 07

US + Brazil Financial News (8/7)

UNITED STATES  

Another month, another NFP report, and the same controversy. This has been an unusually long cycle, in its ninth year, after an unusual recession led by a financial crash and crisis-led deleveraging. The cycle coincided with and/or reinforced structural shifts in the US economy that brought about a lower level of potential growth and, seemingly, a near-permanent shift in the yield curve. The structural real neutral rate is close to zero, if not negative. Moreover, the flatness of the Phillips curve relationship between the output gap and inflation not only survived. If recent empirical evidence is to be believed, it became more pronounced—and entrenched. The argument is that, if the Fed waited to act based on the Phillips curve, it would act too late. Inflation would then be ingrained, and only a deeper recession could cure it. Thus, many argue, it is wrong to focus on measures of the output gap. The preferred measure, instead, is to focus directly on the unemployment gap: The distance between the observed unemployment rate and the NAIRU.What the unemployment gap shows is that the economy is at full employment; i.e., no further slack, notwithstanding any possible lingering controversy about the participation rate. So, why are wages not rising faster? In part, because we should exclude movements among very high-earners. Their remuneration is less dependent on the relative tightness of the labor market. Focusing on lower earners, the link is statistically there and, so they say, will get stronger. Thus, the road remains clear for the Fed, with some patience. And the Fed has a good reason to wait: An announcement about the start of balance sheet tapering in September, with an actual start in early 2018. Bottom line: Fed action in September (announcement of tapering) and December (rate hike) is on the menu. The recovery, albeit slow, is on track without fears of deflation in the relevant horizon. It is a persuasive story, and we buy it.The focus this week will be on the July jobs report that, we expect, will signal that income gains are sufficient to keep consumer spending in the driver’s seat for growth. There will also be several Fed speakers.

  •  Tuesday, August 1: Personal income, June (consensus +0.4%momsa). Personal spending (consensus +0.1%momsa). PCE price index, (consensus flat; +1.3%yoy). Core PCE price index (consensus +0.1%momsa; +1.4%yoy). It was the recovery in personal income and consumption that drove economic growth in 2Q17. And an increase in aggregate income in last month’s job report suggests a continuation of this trend. On the other hand, based on details in the PPI and CPI reports, as well as the firmer price-related news in Friday’s GDP report, core PCE should increase, if little.ISM manufacturing, July (consensus 56.4). Recent regional surveys suggest a decline in July of about 1pt. There were declines in the Empire State, Philly Fed, and Kansas City manufacturing surveys. As we noted, the ISM and other sentiment indicators were running ahead of actual data, overstating actual output gains; a correction is overdue. The key will be to watch two key subcomponents –new orders (June: 63.5) and production (June: 62.4).
  • Thursday, August 3: ISM non-manufacturing index, July (consensus 56.9). Regional service sector surveys were mostly weaker in July, suggesting a pullback from 57.4 in June. Note, however, that even a weaker reading would continue to indicate expansion in services activity. Since December 2009, the index is above 50—and it has correctly identified the strength in the services sector — the 12-month pace of services spending has not contracted since January 2010.Factory orders, June (consensus +2.8%momsa). Core capital goods orders (last -0.1%). Core capital goods shipments (last +0.2%). The bounce back from May reflects a sharp rise in commercial aircraft orders. Core orders could decline in June and in coming months, as well as shipments. The auto sector appears to have peaked, and production of consumer goods has waned in recent months, which is indicative of a cooling manufacturing economy.
  • Friday, August 4: Nonfarm payroll employment, July (consensus +180k = the 6mo mov-avg). Average hourly earnings (consensus +0.3%momsa; +2.4%yoy). Unemployment rate (consensus 4.3%). If GDP growth is to pick up in 2H/2017, it will require faster household income creation. This should develop as labor slack dwindles. Labor market fundamentals remained solid – business employment surveys remain at strong levels, and the Conference Board’s labor market differential rose to a 16-year high.Trade balance, June (consensus -$44.8bn). The Advance Economic Indicators report last week showed a narrower goods trade deficit. The trade balance has long had an uneven, up-and-down, performance. Trade added only 0.2 bps to the 2.6% increase in real GDP in 2Q. Fortunately, the worst fears about trade and the Trump administration
    are, so far, speculative.

BRAZIL

Congress returns from recess, and the Lower House could vote on the charges against Temer on Wednesday. There may not be a quorum, of at least 342 members. The President wishes otherwise, hoping to clear this hurdle—but he may not win even this. Political attention is
already elsewhere. Unfortunately, not on the Social Security Reform but on the approval of the Political Reform bill. If it is to be binding for the 2018 elections, it must become law by October this year. Of note is that, in the aftermath of the Lava-Jato, the Supreme Court barred all private campaign contributions. Funding for the 2018 campaign will come, therefore, only from the State; and Congress must approve the rules. TV-time is vital. It is well-understood that, in a country of Brazil’s geographic size and demographic diversity, TV is the most accessible bridge to the electorate. The new law will determine the total time local stations must allocate to the campaign, as well as the rules for its distribution between parties.

Likely, the new law will maintain and reinforce the current allocative scheme based on party representation at the Lower House. It may, however, bar coalitions for proportional elections, e.g., elections to the Lower House. This would stop parties from “donating” their TV-time. Another proposal is to bring back the restriction of a minimum hurdle, based on the voting share in the national poll, for access by a political party to the State-sponsored campaign fund. This could discipline the creation of political parties, and the profusion of party representation at the Lower House.

In sum, in debating the Political Reform bill, Congress may be debating its own future. It is likely to be contentious. Ironically, the debate could bring-back together the main parties behind the Temer coalition: PMDB, PSDB and DEM. Together, they could get the lion’s
share of the electoral fund, and of TV-time. They have no interest in forming coalitions for votes to the Lower House. But if they form a coalition for the presidential election, choosing a single candidate, they would start the campaign with a considerable advantage. Their candidate would be the candidate to beat in 2018. Moreover, if the DEM chooses to side with the PMDB and the PSDB, it would remove any lingering plans for Rodrigo Maia to replace Temer as President before the 2018 election.

On the data front, the focus will be on Tuesday.

  •  Tuesday, August 1: COPOM minutes from last week’s decision. The committee did then what the market expected, a 100bp cut in the SELIC to 9.25%. The statement following the meeting suggests that they will repeat the dose on September 6th. The committee dismissed the impact of heightened political volatility either on inflation expectations or the likely path of economic activity. This may be too sanguine: There is a case for slowing down the pace of easing, given increased uncertainty about fiscal and institutional reforms, as well as the stage of the cutting cycle. A cut of 75bps in September may be more adequate, with a final rate between 7.5% and 8%. In the event, the minutes should shed more light on the COPOM’s motivation; on the benchmarks set for the next decisions.Industrial Production, June (consensus 0.1%yoy, which would mean a contraction in the momsa indicator).  Auto production was down in June. Even so, IP could show growth in Q2 of about 0.2%qoq, after an expansion of 1.1%qoq in Q1. This would be an indication that IP found a bottom. Growth ahead will be slow, but it would mark the start of a recovery.Trade Balance, July (consensus $6.3bn). Expect another strong result topping last year’s surplus of $4.6bn. Exports could total $19.1bn (in part due to the export of an oil rig in the 3rd week of the month) and imports, $12.8bn. If correct, the rolling12-mo trade surplus would increase to $62bn, a new record.

 

IMPORTANT NOTICES:

This report is a general discussion of certain economic and geopolitical trends and forecasts.  It does not constitute investment advice of any kind or constitute a recommendation to buy or sell any security or other financial instrument.  Investors may not rely upon any of the conclusions or other statements contained herein.

Certain of the factual information contained herein was obtained from third party sources which the author considers reliable, but the accuracy of such information cannot be guaranteed.