Brazil H210 Slowdown Gathering Steam
My long-standing view that growth will cool considerably in Brazil in the latter part of 2010 is now firmly playing out, with latest industrial production data again surprising consensus expectations to the downside. June figures reveal a 1.0% month-on-month (m-o-m) contraction, the sharpest fall since the height of Brazil’s recession in December 2008. With the rate of growth now having fallen in year-on-year terms in each of the last four months, I am growing ever more confident in my view that more subdued industrial production is part of a broad-based slowdown in economic activity rather than a temporary trend.
The key policy consequence of weakening short-term growth prospects is likely to be a swifter end to the country’s rate hiking cycle. Brazil’s monetary policy council (COPOM) has already signalled that it is adopting an increasingly dovish bias, and followed up its decision to raise the benchmark Selic rate by a more modest 50 basis points (bps) to 10.75% in July (after two successive 75bps hikes) by insisting that economic growth is now easing towards sustainable levels. With the upcoming release of Q210 GDP data likely to show considerably more modest growth than Q110’s barnstorming 9.0% y-o-y figure, and inflation also on a downward trajectory in recent months, I think the imperative to extend the aggressive monetary policy of recent months is fast beginning to wane.
Market Implications: Interest Rate Futures Down
This more benign inflationary outlook is readily apparent on the overnight interbank deposit (DI) futures market, with the January 2011 contract having fallen 51bps since I first set out my bearish stance on the contract back in mid-July. While I think that the fall is a manifestation of investors’ reassessment of their bullish growth outlook on Latin America’s largest economy, I still believe that the full extent of the slowdown likely in H210 has not yet been priced in. As such, I expect the contract to compress further, and am targeting a move to 10.70% over the coming weeks.
