Sep 25

US + Brazil Financial News (9/25)

UNITED STATES  

There were no surprises from the Fed meeting; all as expected: No rate change, and the announcement that balance sheet tapering will begin in October, following the procedures laid out over the spring and summer of 2014, and detailed last June. All the same, it was a critical meeting. First because it was the last one for Stanley Fischer. With his departure, plus, cumulatively, those of other four Board members, the weight of his lingering influence will be critical as a new Board may seek to change the course of policy. Fischer’s guidance was critical, as had been Bernanke’s, in shaping the approach of the Yellen Fed. Second, because, in the Q&A, Yellen made two important clarifications: That the committee in general understands that low inflation in 2017 is not structural but idiosyncratic; thus, that it does not stand in the way of continued rate hikes. That the decision to begin tapering arises from a belief in solid foundations for economic growth. The economic recovery is well-founded. Thus, the process of balance sheet adjustment is not to be countered except for major, unexpected economic disturbances. In fact, Yellen hinted that she thought the Fed would first cut again rates than change the course of balance sheet adjustment.

The new forecasts, and the press conference, reinforced the call for a rate hike in December: Now, 12 out of 16 participants project a hike. There were upgrades to the GDP and employment forecasts, and, as noted, continued skepticism from Yellen about the significance of the weaker-than-expected core inflation numbers. We expect that the hike will come. Following a long course of downgrades to the terminal rate, this set of projections brought it down, again, to 2.8%. In other words, the long-run expected real rate is only 0.8%. Considering that the terminal rate would be close to what the Fed expects the underlying neutral real rate to be, and that Yellen often refers to today’s real underlying neutral rate as close to zero, both, the Fed expects the neutral to rise, and not by much. Still, given that by 2019 and beyond the Fed will be different, the market seemed to dismiss this possibility.

This is a busy week for data; a slew about the housing market, new readings of confidence, durable goods, a new (final) reading of Q3/GDP, personal income, consumption, and the PCE deflator. It also brings a couple of important Fed speeches; the last one from Fischer and a policy-related one from Yellen.

  • Wednesday, September 27: Durable Goods Orders – August. (Consensus 1%momsa; ex-transp 0.3%momsa; Capital goods shipments nondefense ex-aircraft 0.5%momsa). Core durable goods orders drifted steadily higher since mid-2016. Growth in core shipments crossed into positive territory in early 2017, after a two-year long slump. Shipments (which are part of GDP) are now in a healthy recovery, although in nominal value they are barely back to the level at end-2011. The post-hurricane rebuilding should reinforce the trend, at least temporarily.
  • Friday, September 29: Personal Income, Spending, Deflator – August. (Consensus, income +0.2%momsa, spending +0.1%momsa; core deflator (PCE) 0.2%mom; 1.4%yoy). Distortions related to Hurricanes Harvey and Irma will probably show up. Even so, the underlying trend for income and spending is strong and steady. Nominal PCE is up 4.2%yoy in July; 2.7%, real. This continues to drive the economy. In fact, this week will also show the third revision to Q2/GDP, which showed (and is expected to continue to show) personal consumption growth of 3.3%saar. The story for the deflator is another. The core PCE deflator is languishing at 1.4%yoy, well below the Fed’s 2% target. The picture should change in August. However, Yellen’s post-FOMC conference provided some relieve. She was quite explicit in attributing the 2017 slowdown to special, “non-structural” circumstances. The takeaway is that these momentary low numbers will not spook the Fed. As discussed above, we expect a hike in December—despite low inflation readings, including in the Fed’s own most favored indicator.

    Mich. Sent. – Final. (Consensus 95.3). The question will be the impact of the Hurricanes. Will it already come in this reading? After Katrina, sentiment dropped 20 points. Sandy pushed the index down 10 points. The impact of each was short-lived. At this stage, the short-term risk is for lower confidence readings. That said, confidence has been running high, and will probably remain resilient to short-term fluctuations.

 

BRAZIL

The main event this week is the publication of the results for the public sector for August. There may be good news, on a gain in real revenues after months of decline. But the overall picture is awful. At end-2016 the overall deficit was 9% of GDP, and the primary deficit, excluding interest payments, 2.5% of GDP. There has been little improvement since. Likely, the 12mo primary deficit to August will sum to R$165bn with the addition of a R$17 deficit for the month. It would be an improvement over July, simply because the Aug/2016 result, that would fall off from the 12mo sum, was unusually high. The underlying deficit would be running at close to $170bn, thus R$10bn above the just revised yearend target. To meet the target, the budget would have to count on extraordinary revenues from privatization. They now seem more likely, given that a Federal Court lifted the injunction against the auction of CEMIG’s power plants, and the auction is likely to proceed before yearend. This would bring the accumulated deficit by yearend down by about R$10bn, enough to meet the revised target, but without any progress vis-à-vis the results of 2016.

The picture for 2008—the election year—is darker. When the 2018 preliminary budget draft (PLOA) was sent to Congress on August 31st, the plan was to close the year with a deficit of R$66bn, or 0.9% of GDP. A couple of weeks later, the target changed to R$159bn, the same target that was set for 2017. Likely that would sum to 2.5% of GDP, practically the same as in 2016-17. The implication, of course, is more debt—and, with it, a destabilizing path to the Debt/GDP ratio. Forecasts now show the debt growing to 95-98% of GDP by 2022, even with stable monetary policy and a lower path for the real interest rate. A decade earlier it was at 51.5% of GDP! But that is not all. To date, the government has not sent the 2018 budget document to Congress. Despite the more generous revised deficit target, it seems that the accounts don’t square. The culprit is social security, the relentless growth in payments, both for the private and the civil service subsystems. A change is unavoidable. Unfortunately, we don’t think it will happen in this administration. In fact, we expect the fiscal picture to deteriorate beyond the currently envisaged targets. This would leave the new administration, beginning in 2019, with a heavy burden: Implement structural fiscal reform, including social security, right at the start; or face a collapse of confidence with holders of the public debt.

This will be a busy week on the data front with, in addition to the fiscal data, new numbers for credit and NPLs, consumer confidence, unemployment and the external accounts.

  • Tuesday, September 26: Central Bank – External sector report – August. (Consensus, CAB -$400m; FDI +$6,550m). With a smaller monthly deficit, given lower outbound flows of profits and dividends, the 12mo current account deficit could drop to 0.6% of GDP. The deficit was 1.65% of GDP in the same month in 2016, and 4.35%, in 2015. The sharp reduction attests to the speed with which the Brazilian economy adjusted to the change in the real exchange rate, terms-of-trade, and, most of all, to the drop in the demand for imports following the recession that is just over. As the economy recovers in the months ahead, we expect imports to grow and the CAD to be somewhat larger, in the order of 1.5-2% of GDP 12mo ahead. Financing it should not be a problem. FDI is running at 4.5% of GDP (12mo sum) and is not foreseen to decelerate, on the contrary.
  • Friday, September 29: IBGE – Unemployment rate (PNAD-contínua) – August. (Consensus, 12.7%). Unemployment is finally falling. After 43mo of uninterrupted increases, that brought the rate up from 6.2% in Dec/13 to 13% in Jun/17, it climbed down in July to 12.8% and is expected to decline further in August and in the months ahead. Job creation in the formal economy (wage workers) was positive in August. Meanwhile, real income per worker is also up (0.9%yoy in August). The relative resilience of real incomes, when confronted with massive unemployment, helps explain a recovery based on consumption, so far. Part of the cause must have been the unexpected decline in inflation.

    Central Bank – Fiscal report – August. (Consensus, Primary Deficit R$17bn; Nominal deficit R$52.5bn). See above.

 

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.