UNITED STATES
- Wednesday, July 26: FMOC rate decision: No rate change, but look for: (a) acknowledgement that job growth improved and that the recovery remains robust; (b) recognition that inflation declined further and is a problem, at least in the short-run. Yellen and others at the Fed-Wash distinguish, seemingly, two paths, one for rates and another for balance sheet adjustment. The puzzle of low inflation, of the failure of wage growth to pick up at a faster pace, and of imperfect transmission from wage growth to prices, all point to moderation in rate increases. The market has given up on September, and is doubting December. Likely, the Statement will keep December in play. Meanwhile, regarding the balance sheet, Fed officials point to the economy and financial conditions, alone. So, there is less doubt: Q2 GDP should be above trend (see below) and indices of financial conditions show improvement, in part due to the weaker USD. Balance sheet adjustment is nearby, and the Committee may something concrete about it on Wednesday. A start of balance sheet normalization in Sept/Oct.
- Thursday, July 27: Durable goods orders (June). Headline: 3.5%momsa; Capital goods shipments ex-defense and aircraft: 0.3%momsa. Large aircraft orders will impact the headline. Core shipments (the number that goes into GDP) is running at a modest, albeit positive rate. Recall that manufacturing output did poorly in June (0.1%momsa ex-autos).
- Friday, July 28: Q2 GDP (first reading). Headline: 2.5%saar, likely somewhat les; Personal consumption: 2.8%saar; PCE deflator: 0.7%saar. BEA will also release historical revisions to the data. Growth was below trend in Q1 with weak consumer spending and an inventory drag. Both likely reverted in Q2. As a result, expect above trend headline growth. Attention will focus, again, on the PCE deflator—likely a very low reading. See our comments about the FMOC meeting.
BRAZIL
Congress and the Judiciary are in recess, a relief for markets, and President Temer. The highlight this week is the COPOM. I expect a cut of 100bp to 9.25%, the first time Since Oct/2013 that the SELIC target is below double digits. More commentary below. There will also be data on unemployment (June) and the fiscal results for the consolidated public sector (June).
Recent data from all fronts confirm that the economy is in a robust and persistent disinflationary trend. It is not surprising. Domestic aggregate demand is down sharply. Using FGV’s GDP indicator for May/2017 (12mo/movavg) consumption is down 2.5%yoy and investment, 5.4%. The formal labor market continues to shed jobs, and unemployment, to increase. Real incomes trend down, with an accumulated loss in GDP of 7.6% between May/2014 and May/2017. The positive shocks from food and energy prices reinforce the loss in corporate pricing power, and help diffuse the disinflationary spiral. The exchange rate is stable. The external adjustment is complete: the current account was in surplus in H1/2017, with strong FDI inflows. The IPCA’s diffusion index (a measure of price dispersion) is down to 45.2%, a near record low, and 20bp below its 5yr average. All measures of core inflation show inflation at 4%yoy or lower. The outlook is more of the same—even with the possible transitory impact of higher energy prices following last week’s tax increases. (The add-valorem tax –PIS/COFINS—on gasoline increased from 0.3816% to 0.7925%; on ethanol, from 0% to 0.1964%.) Inflation expectations are firmly anchored by credible monetary policy. And the recent political turmoil did not change this. The question, therefore, is not whether there is room to cut, but how much to cut in total. The thought is that the rate could go as low as 7%—a whopping 725bp below where the rate was at the start of the cutting cycle that begun in Oct/2016.
Two issues are at stake,
- Where is the underlying neutral rate? Given that the rate of investment dropped 28% (accumulated) in the last 3yrs, and was never above 17% of GDP, most time-series-derived measures of potential GDP are near zero; assuredly, below 1%pa. That is the conjunctural measure. It could give pause to attempts to cut radically the policy rate, were it not for the fact, as discussed, that aggregate demand, albeit likely at a turning point, is so low. The more relevant measure is the “structural” rate, fruit of the long-run expected growth in the labor force, of its productivity, and of the supporting institutional/policy environment. That is also low, estimated at about 2%pa. Certainly, in 2018, the economy will not growth much above this. The question then is what is the SELIC rate that would keep the economy churning at this pace, in the steady-state? It is hard to find a convincing answer. One way is to look at uncovered interest rate parity. Start with the real long-run US policy rate (0-1%), add the long-run expected inflation differential (2-2.5%) and the country spread, another 2-2.5%. So, by this simple estimate, the long-run “neutral” would be somewhere between 4-6% real, or 8-10%, nominal. This helps explain why so many analysts had their minds set at 8%, as the terminal rate. Of course, one could argue that, with improvements in policy and performance, the country spread could go down to 100bp, even lower. That could place this simple measure of the “neutral” at somewhere around 7% nominal.
- 2018 is a political year, and the most probable cause for adverse expectations is political; namely, a failure to sustain fiscal outcomes and prospects. Given this, is it worth it to push rates below neutral in 2018? We know that, in 2018, even in the best possible scenario, the economy will have a lot of slack. Why not bring the rate lower? Why not more accommodation? It would help elect someone with a commitment to maintain the policy course. One argument would be caution. Arguably, the COPOM would not want to have to increase rates in 2018. It could, therefore, ride the cycle and keep the rate where it would want to have it at the start of 2019 when, if the scenario is positive, the economy would be reviving strongly enough to recover its cruising speed. So, an 8% rate could ride through 2018 and, likely, through 2019.
In the event, it may be too soon to call the final rate. What is near certain is that the next move, next week, will be a cut of 100bp to 9.25%.
- Tuesday-Wednesday, July 25-26: SELIC rate announcement (COPOM). See above.
- Thursday, July 27: Durable goods orders (June). Headline: 3.5%momsa; Capital goods shipments ex-defense and aircraft: 0.3%momsa. Large aircraft orders will impact the headline. Core shipments (the number that goes into GDP) is running at a modest, albeit positive rate. Recall that manufacturing output did poorly in June (0.1%momsa ex-autos).
- Friday, July 28: Q2 GDP (first reading). Headline: 2.5%saar, likely somewhat les; Personal consumption: 2.8%saar; PCE deflator: 0.7%saar. BEA will also release historical revisions to the data. Growth was below trend in Q1 with weak consumer spending and an inventory drag. Both likely reverted in Q2. As a result, expect above trend headline growth. Attention will focus, again, on the PCE deflator—likely a very low reading. See our comments about the FMOC meeting.
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.
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