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Our April Economic Report shows the consequences of widespread inflation and highlights how the Federal Reserve’s (Fed, the US central bank) change in stance has already produced a relevant tightening in global financial conditions.
Due to the process of normalization of monetary policy in the world, stock markets have been facing severe corrections. What draws attention in this market correction is that fixed income, which in general acts as a balance in investment portfolios, also presents a negative result, due to this change in the posture of global central banks.
Another consequence of the tightening of monetary conditions is the appreciation of the dollar, due to the increase in the interest rate differential – which justifies the rapid devaluation of the real in April.
Our March Economic Report highlights the heating up of the US job market where the ratio between the number of unemployed and the number of vacancies dropped significantly in the post-pandemic period.
This scenario, combined with the persistence of inflation and a more hawkish stance (with a bias towards raising interest rates) adopted by the Federal Reserve, the American central bank, has led to a significant increase in expectations for the cycle of interest rate hikes. .
In Brazil, the Real benefited from the rising commodities environment. After the acceleration of commodity prices, the flow of international capital began to seek assets, especially currencies, in emerging economies.
The escalation of the conflict between Russia and Ukraine has led to a significant increase in commodity prices. In our February’s Economic Report, we explained that, in addition to the immediate inflationary impact, an eventual supply cut could limit Europe’s growth for example, which is heavily dependent on Russian natural gas.
In the US, the accelerating global inflation environment and a significant change in the Fed’s speech made the market price a more abrupt start to the hikes cyccle in interest rates.
This inflation scenario and high interest rates combined with the commodities boom, has led the American stock market to reverse its behavior, reflecting a more favorable performance for value assets than for growth assets.
The US, UK, Japan and European labor markets have converged to better levels and are generally close to pre-pandemic levels. In our January Economic Report, we explained that this movement has been one of the main vectors of the hawkish steer – a bias towards an increase in interest rates – from the Central Banks in these regions.
In Brazil, the proposals for tax exemptions to contain the rise in fuel prices is the main highlight. In the long term, they should imply an increase in country risk and a deterioration in inflation expectations, as shown by the Monetary Policy Committee of the Central Bank (Copom).
In addition, the Committee’s most recent minutes indicated that the Selic rate hike cycle should be slightly more intense and lasting than expected, reaching a rate above 12% p.a. in May — and going on so for some time.
The Ômicron variant has led to record numbers of Covid-19 cases, but hospitalizations and deaths have not kept up with this pace. In the December Report, we explained that we expect a negative response in activity indicators – especially services –, but that this movement should quickly reverse.
In the US, the recovery of the #labor market has been rapid. With employment and activity at more expressive levels, the Federal Reserve (Fed, central bank) has adopted an increasingly rigid discourse in relation to the fight against #inflation. The monetary authority intends to tighten financial conditions, which are highly stimulating.
In Brazil, the current cycle of high #interest rates was much faster and more intense than the market projected at the beginning of 2021. The high level, added to the presidential elections, should create a complex environment for risk assets, at the same time in which they can create investment opportunities, with attractive valuations in many cases.
Inflation has been an important thermometer for global markets. The rise in prices is linked to temporary factors – such as the cost of energy and the bottlenecks between supply and demand – in addition to the effects of the monetary and fiscal stimuli adopted.
On the stock exchange, it is worth highlighting the negative performance of the sectors that are more sensitive to social contact – such as aviation, entertainment and maritime transport, which had their performance linked to the discovery of the new variant.
In Brazil, the conjunction of rising inflation, GDP back below pre-pandemic levels and the discovery of the new variant of the coronavirus set the tone for the month, bringing even more volatility to the markets.
The challenging internal scenario also led to a significant reduction in the multiples of companies listed on the Stock Exchange. Many are even traded at a level below the worst moment of the pandemic, suggesting that a significant portion of the risks for assets may already be priced.
One of the most relevant issues for financial markets has been the discussion on how temporary inflation is affecting several countries, developed and emerging.
The worsening in inflation data can be attributed to shocks in the supply chain and reopening of economies. The sronger-than-expected persistence of inflationary pressure has led the main central banks to adopt stricter monetary policies than previously proposed.
The deterioration of the fiscal framework also had repercussions on monetary policy decisions in Brazil, with the BC opting to accelerate the hikes in the interest rate.
Despite the favorable external scenario, uncertainties in the fiscal scenario strongly impacted domestic risk assets, including the stock market – the Ibovespa had another month of declines, despite the strong performance of global stock markets, including emerging countries.
The latest global data indicate that the number of new cases, hospitalizations and deaths caused by Covid-19 are slowing down, which rises expectations around the advancement of economic reopening.
In the United States, the monetary policy committee (FOMC) showed that a relevant part of the members expects interest rate hikes as early as next year. Additionally, Chairman Jerome Powell suggested that the tapering process could start in November and end in mid-2022, at a faster pace than market expectations.
In Brazil, growth expectations for 2022 have been consistently revised downwards, as internal and external factors, such as the water crisis, the uncertainty of the fiscal and political scenario, the scarcity of supplies and global inflation present themselves without a clear solution in the short term.
Covid-19’s third wave globally has had a contained impact on mobility in the US. However, the country’s job market has been impacted by the new wave of the disease, temporarily interrupting the North American economic reopening process.
In Europe, the main highlight is the general elections in Germany, whose voting intention surveys point to a very volatile and uncertain scenario among candidates.
In Brazil, the water crisis remains worrying, with an immediate impact on the price of electricity. Although the composition of the energy matrix has become less dependent on water sources in the last 20 years, hydroelectric plants continue to represent the largest share of the electricity supply. Thus, the beginning of the rainy season in November will be a watershed for the local scenario.
Internationally, second quarter GDP in the United States came in below expectations but showed robust growth, led by consumption. In addition, US inflation has been surprising – but a significant part of this surprise comes from shocks in very specific components.
In China, the reduction in the compulsory deposit rate represented a loosening of monetary policy. The decision seems to indicate that the PBOC (People’s Bank of China) is now seeking an adjustment in its policy margin, after quarters marked by a restrictive stance.
In Brazil, a number of factors such as rising commodity prices, water shortages and agricultural losses caused by weather factors have led to an escalation in inflation. In the fiscal scenario, a higher-than-expected amount for the payment of precatories and the expansion of social programs represent a new threat to the spending ceiling.
In the international scenario, some countries already have over 60% of their population vaccinated with at least one dose. However, with new variants emerging, the number of Covid-19 cases have accelerated. The good news is that hospitalizations and deaths are not following this acceleration, which reduces this wave’s social and economic impact.
In the United States, the Fed signaled that the interest rate would rise twice in 2023 – a relevant change from March’s meeting in which it had announced interest stability. Even so, the message remains that the normalization process should be slow and gradual.
FED’s change in statement had an impact on commodities which, although they showed a robust increase in 2021, suffered relevant corrections in recent weeks.
The combination of robust growth with well-behaved long-term interest rates in the US also resulted in a significant overperformance of growth stocks (companies with high long-term growth potential). During the year, these stocks had a much worse performance than value stocks (companies whose price is considered below their intrinsic value). Now, the difference between them has been significantly reduced.
In Brazil, June was once again a very positive month for the flow of foreign investors to the stock market. This movement is mainly due to positive growth reviews and reduced fiscal risk perception with lower expected debt/GDP numbers at the end of 2021.
On the international scene, Europe accelerated its vaccination process, which generated greater optimism with the resumption of the bloc’s economy in the coming months – in particular with the arrival of summer, when activity in the service sector is more intense.
In the US, April and May inflation readings surprised forecasts well and raises the question of how these shocks might impact US monetary policy.
In Brazil, the 1st quarter GDP also surprised and led to a round of strong upward revision in growth projections for 2021, which are already around 5.5%.
On the other hand, the low level of rainfall and strong demand raised the alarm of risk of problems with the supply of electricity in the country, which translates into higher tariffs.
Finally, although the country’s structural challenges in fiscal terms have not changed, upward revisions to growth and inflation projections resulted in a lower estimate for the gross debt/GDP ratio at the end of the year – which makes the dynamics of the coming years less unfavorable.
The North American immunization program is quite advanced. This success and 2021’s strong fiscal impulse, with the direct transfer of resources to the population, have resulted in a rapid reopening process of the economy.
Even with strong data, Fed’s stance has remained firm and the institution has already stated that it should maintain high monetary support.
In Brazil, before the new lockdowns announced, economic activity had been showing better-than-expected results. Highlight for the increase in the IBC-Br, monthly GDP proxy calculated by the BC, which in February was already 2.3% above that observed in the pre-pandemic period.
On the other hand, inflation, despite some bearish surprises at the margin, remains under pressure. In the short term, with the strong movement of #commodities, this pressure should continue. But the relevant idleness still present in the labor market, added to the reduction of fiscal and monetary stimuli this year, should mitigate a more consistent acceleration of prices.
In March, the United States and United Kingdom stood out with their vaccination pace, while the European Union followed well behind. This divergence should be reflected in the reopening speed and in the performance of these economies in the coming months.
In the US, the last monetary policy committee meeting kept the interest rate signal stable at 0% until the end of 2023 – despite strong economic results. The market, however, continues to doubt this signal and prices around three highs.
In Brazil, with the still worrying signs of COVID-19 in April and restrictive measures being extended in several states, the start of the second quarter should be challenging for economic activity.
In Politics, the noise surrounding the Brazilian fiscal trajectory, intensified by the impasse of the 2021 budget, has been reflected in the risk premiums on the yield curve. While the BC insists on a partial normalization of the Selic – which, according to the recent communication, would mean a rate of around 4.5% –, the pricing on the yield curve is 6.5% at the end of the year, reaching around 10 % In the next years.
In February, the pace of vaccination in the United States was impressive due to its speed. The North American performance was better than the European one, which reflect in how different these economies will grow over the next few months, with a faster reopening of the US. In Brazil, the new lockdown measures should impact the recovery of the economy.
Still on the foreign agenda, the approval of a US$ 1.9 trillion fiscal stimulus package also impacted markets. This government disbursement, added to the reopening of the economy and the very accommodative monetary policy, should produce a strong acceleration of North American growth over the next few quarters.
In Brazil, the Central Bank (BC) should announce a hike in the basic interest rate in March. One of the main reasons for this outlook is the worsening inflation outlook.