Brazil is experiencing a special economic time. On the one hand, foreign trade is very dynamic with rising commodity prices. But on the other hand, very high inflation threatens domestic demand. This translates into a strong real and a stock exchange that evolves like a saw tool on the financial markets: explanations and advice follows.
The spectre of hyperinflation
As in virtually every country in the world, Brazil is facing a sharp rise in inflation. However, the country’s structural deficiencies exacerbate the price slide. The rebound in post-conflict domestic demand quickly saturated Brazil’s productive and logistical capacities, accentuating inflationary pressures. As a result, inflation surpassed the 12% mark against less than 2% two years ago. However, the central bank tightened its monetary policy as of Q1 2021. It even hit hard by lowering its key interest rate from 2% to 12.75% over the past 15 months. And a new rent increase for the money is scheduled for June 15.
The Brazilian monetary authorities are trying to avoid an increase in inflationary expectations and an uncontrolled price slide. This monetary overactivity is explained by the painful memory of hyperinflation that has repeatedly ruined the Brazilian economy and plunged millions of households into poverty. The last episode dates from the mid-1990s and is still well remembered.
Domestic demand in peril
Soaring prices and rising money rents cloud Brazil’s economic outlook. Business investment is already down. On the household side, the decline in purchasing power and the rise in credit will put a firm brake on spending in the coming months. Moreover, domestic demand will be weaker as the October presidential election is a significant source of uncertainty for economic agents.
The latest polls still give former President Lula victory over the current Head of State Bolsonaro. But Lula’s program remains fuzzy. A return to the policies implemented during his stay at the presidential palace from 2003 to 2010 is not recorded. To defeat right-wing extremist Bolsonaro, the former President has formed a broad coalition around him. In particular, he chose a figure from the right as his running mate. Resolutely on the left during the 2002 campaign, Lula is now in the centre to reassure and gather as much as possible the disappointment of Bolsonaro.
Exports as a lifeline
Economic activity increased by 1% in the first quarter compared to the previous three months. It was the export boom that allowed the economic recovery to continue. The war in Ukraine has had a double impact on the Brazilian economy. On the one hand, it has strengthened price slippage and will force monetary authorities to maintain a restrictive policy for longer. On the other hand, it promotes exports from Brazil, a major player in world trade in raw materials. As a result, Brazilian sales abroad reached record levels in March and April. This has salutary critical consequences.
The export boom boosted export activity and dampened the weakness of domestic demand. High commodity prices will also support investment in the mining and agricultural sector. Finally, Brazil is expected to post a record trade surplus this year. This improves the country’s financial situation by reducing the need for foreign financing. Badly damaged by the Covid pandemic, public finances also benefit from welcome additional tax revenues.
Real at the party
Investors welcome the improvement in the country’s financial situation. But above all, the independence of the Central Bank, now legally entrenched, and the rise in the key interest rate attracted investors.
Since February 2021, the law protects the Governor of the Central Bank from any threat of dismissal by the government and any interference in monetary policy. With this new protection, he started raising the rent of money the following month to contain the price slippage. This first monetary tightening was a turning point for the real in the foreign exchange market. Falling to a historic low against the euro on March 9 2021, the Brazilian currency has since recovered. It has even appreciated significantly in recent months thanks to the high-interest rates and the sharp rise in prices that have highlighted this “commodities” currency.
An interesting diversification
There is no indication that the appreciation of the Brazilian real will continue in the coming months. And in the medium term, the Brazilian currency will certainly depreciate against the euro. But the very high-interest rates offered by Brazilian debt offset the expected decline in the currency. Real bonds are an interesting diversification, up to 5% regardless of your risk profile.
The Brazilian stock market, where the share of mining and agri-food companies is significant, also benefited from the surge in commodity prices. But the movement has reversed in recent weeks. Weak economic prospects and political uncertainty have diverted investors from the Brazilian market in the coming quarters. In anticipation of greater political visibility, we also prefer to avoid Brazilian stocks. Don’t buy. For diversification, we still keep 5% of Brazilian bonds for our neutral portfolio.