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United States Review and Preview Central Europe ULC Headaches Brazil Commodity Challenge – Choose Your Poison View GEF Archive

		The Global Economics Team

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Treasuries posted marginal gains across the curve over the past week after the Fed provided a balanced risk assessment that left policy firmly on hold, jobless claims and chain store sales were weak (though on an underlying basis, it’s unclear how much so for claims), and the refunding auctions went well.  A terrible performance by mortgages − which were the primary focus in interest markets throughout the week, with Treasury trading a clear sideshow to MBS − with spreads moving out to a series of all-time wides through much of the week before finally seeing a decent partial recovery Friday, had a mixed impact but overall was probably a drag on the market.  It was clearly so during the first part of the week, when the upcoming refunding supply also weighed on the market and drove a bear steepener even as Fed rate hiking expectations were being sharply scaled back in the futures market following the balanced tone of the FOMC statement.  When the weak data arrived Thursday, however, and the market was also being boosted by the solid results at the 10-year and 30-year auctions, which both saw strong overall demand and good participation by final investors, weakness in stocks, and a big rally in Europe after a relatively dovish ECB press conference, Treasuries benefited from the meltdown in the mortgage market in a flight-to-quality move, which then appeared to reverse Friday as mortgages snapped back while Treasuries sold off slightly.  Volatile stocks were largely ignored through the first part of the week, but a big sell-off Thursday added somewhat to the market’s gains, while Friday’s big rebound pressured Treasuries to end the week.  The sluggish chain store sales results for July combined with the previously reported awful motor vehicle sales numbers provided a clear indication that payback from the stimulus boost to spending in the spring has begun.  Real consumption in 3Q appears at this early point to be on track for a decline, which would likely result in minimal growth in overall GDP.  The second quarter appears to have been a bit stronger than the advance estimate of +1.9% as some of the missing data BEA had to make assumptions for were released and surprised to the upside.  All of the upside to 2Q at this point, however, has come from higher inventories, which has offsetting negative implications for 3Q on top of the weak outlook for consumption.

On the week, benchmark Treasuries posted marginal gains, with the 2-year yield down 1bp to 2.50%, the 5-year 1bp to 3.215%, the old 10-year 2bp to 3.93% (the new issue ended the week at 3.95%), and the 30-year 1bp to 4.55% (the roll on the new bond was marginal).  TIPS continued to get crushed on a relative basis as energy prices continued plunging and the dollar surged.  September oil fell another US$10 a barrel to US$115.20, September gasoline US$0.20 a gallon to US$2.89, and September natural gas US$1.14 per MMBtu to US$8.25.  For oil and gasoline, these were the lowest prices for the front-month contract since May 1 and for natural gas since February 7, and down from recent closing peaks of US$145.29, US$3.57 and US$13.58, respectively, all hit on July 3.  In response, TIPS badly underperformed again.  The short end continued to get massacred (the inflation breakeven on the Jan 09 issue was down another 100bp again), and very weak performance extended into the intermediate sector, though the long end did relatively a lot better, with the 5-year yield up 12bp to 1.19%, the 10-year 10bp to 2.23%, and the 20-year 3bp to 2.15%.  At just 2.03%, the benchmark 5-year inflation breakeven has now fallen 70bp from the high hit coincident with the peak in energy prices on July 3. 

Mortgages were the week’s key focus in the interest rate world, as they traded horrendously through the first four days of the week before a big partial recovery Friday – a potential sign that the all-time cheap levels hit Thursday may have finally reached the point where investors are willing to step in again.  Our desk won’t be convinced we’ve seen a true turning point until Asian buyers return, and we haven’t seen any real evidence of this yet. Through Thursday, current coupon MBS had underperformed a big widening in swap spreads − the benchmark 5-year spread moved out 7.5bp to 101.5bp through Thursday before a good tightening Friday to close the week at 98.5bp − by a huge 23 ticks to send Libor OAS spreads to record levels near +85bp at Thursday’s close and up towards +90bp in late trading Thursday evening.  The prior record spreads during the Bear Stearns blow up were in the mid-70s, and record-wide closes were hit every day from Monday through Thursday.  Friday, however, mortgages outperformed the good swap spread tightening by about 16 ticks, for a net underperformance on the week of about 7 ticks, and spreads came down to below +80bp, still extraordinarily high but at least for once recently moving in the right direction.  Still, the modestly negative performance for the week as a whole − the dollar price on 5.5% MBS still declined slightly on the week − means that home buyers are likely to see even higher mortgage rates in the coming week.  Average conventional 30-year mortgage rates have already been running at levels above 6.5% over the past few weeks (and jumbo rates at 7.5%), highs since last summer and up from around 6% in the spring.  This presents a clear risk to what had been a stabilizing trend recently in both existing and new home sales, and it will take a much bigger sustained improvement in the MBS market after Friday’s rare recent day of strength for mortgage rates being offered to consumers to get back towards those 6% spring levels.  Given where Treasury rates are, in previously normal times 30-year mortgage rates would have been closer to 5.5%, but that’s probably out of the question any time in the foreseeable future, given current market conditions.

The significantly worse-than-expected GSE earnings results contributed to some extent to the weak performance of agency MBS through the first part of the week and more modest net underperformance for the week as a whole.  But straight agency debt, while also cheapening on the week, continued its recent trend of holding in much better than agency MBS, so general concerns about the financial stability of the GSEs have not been the main driver of the MBS meltdown, which at least until Friday appeared to be a simple problem of steady, but generally not especially heavy, selling into a market with almost no buyers, with the GSEs not adding to their portfolios and the key Asian investor base on the sidelines.  10-year agencies ended the week near Libor +8-9bp, up from close to +5bp at the end of the prior week, and Libor flat at the end of the prior two weeks. 

A volatile week for stocks ended up with the S&P gaining almost 3% to its best close since late June.  Treasuries largely ignored risk markets through the first part of the week, when focus was on the FOMC, refunding supply and the meltdown in the mortgage market, but a big financials-led sell-off contributed to a sizable Treasury rally Thursday (though it was only one contributor along with weak economic data, dovish ECB rhetoric, and a very strong 30-year auction) and then a financials-led surge in stocks weighed on Treasuries Friday.  The inverse correlation between Treasuries and financial stocks that was pretty tight for quite a while and then appeared to break down substantially after the Merrill Lynch ABS CDO sale seems to be back to some extent, though still not nearly to the degree seen before the Merrill move.  Although they ended strong, financials were still laggards for the week, with the BKX banks stock index gaining 1.6% and S&P 500 investment banks sub-index 1.1%.  In contrast to the stock market rally, other risk markets were mostly softer.  In late trading Friday, the investment grade CDX index was 2bp wider on the week at 134bp.  Through Thursday, the high yield index was 18bp wider at 716bp, though the losses were being pared a bit by a small rally Friday.  Through midday Friday, the leveraged loan LCDX index was similarly 13bp wider at 407bp, which would be its worst close since mid-July, though this index has mostly been relatively narrowly range-bound since late June.  The struggles in the MBS market continued to spill over to a much more limited extent into the commercial mortgage CMBX market, with the AAA index widening 3bp to 166bp, the AJ 6bp to 502bp, and the AA 40bp to 752bp (with the lower-rated indices doing comparatively worse).  The subprime ABX market was mixed overall on the week, but the AAA index extended its rallying trend since the Merrill sale, gaining another 0.82 point to 45.07.

With the FOMC statement providing a plainly balanced risk assessment that was toned down from a slightly more hawkish take in June – this time the FOMC simply saw downside risks to growth and upside risks to inflation, whereas in June it saw downside, but diminishing, risks to growth and upside, and rising, risks to inflation – Fed rate hiking expectations in the futures markets were sharply scaled back.  The expected timing of the first hike was shifted out to December from October, and even in December the market now sees a rate hike as only slightly more likely than no move.  We continue to see the Fed on hold well into next year.  For the week, the October fed funds contract gained 4bp to 2.045%, November 8bp to 2.08%, January 11bp to 2.14% and February 9.5bp to 2.28%.  Front eurodollar futures significantly lagged these gains, with the Sep 08 contract up 1.5bp to 2.825%, Dec 08 2.5bp to 3.015%, and Mar 09 3bp to 3.095%.  As a result, there was a significant widening in forward 3-month Libor/OIS spreads, which have now fully reversed the modest initial positive response to the Fed’s announcement that half the TAF program would be shifted from 1-month to 3-month loans.  Spot 3-month Libor also rose marginally on the week to 2.80%, which sent the spot 3-month Libor/OIS spread up 3bp to 77bp, a three-month high (though not significantly above levels seen through July).  We’re still optimistic that the TAF extension can have a positive impact on these badly strained term funding levels, but investors seem to have given up hope for any improvement any time soon. 

It was a light week for economic data.  The most notable releases were soft overall sales results from major retailers for July.  While some categories – notably clubs, which continue to benefit to a substantial extent from high gasoline prices – held in relatively well, results for clothing and department stores were quite soft.  Incorporating these data, on top of the previously released collapse in July motor vehicle sales to a 16-year low of just 12.5 million units annualized, we cut our July retail sales forecast to -0.4% overall and +0.4% ex autos from our preliminary forecast of -0.1%/+0.6%.  Broad personal consumption spending in June jumped 0.6%, but this was more than accounted for by surging prices.  Real PCE declined 0.2% in June, and we expect a similar decline in July, which would put 3Q consumption on track for a small decline after the spring boost provided by the tax rebate checks supported a modest 1.5% rise in 2Q.  The payback from that stimulus boost seems clearly to be underway, and we expect this to continue to weigh on spending for several months going forward on top of terrible underlying consumer fundamentals − falling wealth, falling underlying real income, a major tightening of credit availability and very low confidence.  Of note in the chain store results, looking beyond July is that major rebate check distributions finished on July 11, and many retailers noted a worsening in sales trends later in the month.  And retailing giant Wal-Mart guided to only a 1-2% rise in same-store sales in August.

Growth in 2Q, on the other hand, appears to have been somewhat stronger than BEA’s advance +1.9% estimate.  Both non-durable manufacturing and wholesale inventory results for June came in higher than BEA assumed in filling in missing data when it prepared the initial GDP report, and we estimate that the upside points to an upward revision to 2Q growth to +2.3% from +1.9%.  Note, however, that all other things being equal, a smaller inventory drag in 2Q implies a smaller inventory boost in 3Q, so this upside to 2Q adds to the negative outlook for 3Q provided by the weak consumer spending trajectory.

The economic data calendar is much busier in the coming week, with focus on retail sales Wednesday and CPI Thursday.  Other releases due out include the trade balance and Treasury budget Tuesday, business inventories Wednesday and industrial production Friday:

* We look for the trade deficit to widen US$2 billion in June to US$62 billion, with exports up 1.2% and imports 1.9%.  The export gain should be led by some partially price-related upside in industrial materials and a rebound in capital goods.  All of the import gain is expected to be in petroleum products, as volumes appear to have rebounded significantly after some recent weakness and prices rose sharply further.  On the soft side, inbound cargo volumes through the key West Coast ports showed significant weakness, pointing to a pullback in non-energy goods imports.  Note that our deficit estimate is about US$1 billion narrower than BEA assumed in preparing the advance GDP estimate.

* The July budget deficit is expected to rise to US$95 billion, significantly wider than the US$36 billion recorded in the same period a year earlier.  About US$20 billion of the swing reflects calendar effects and another US$15 billion is attributable to the disbursement of stimulus rebate checks.  Also, outlays by the FDIC jumped by US$15 billion.  A portion of the FDIC’s spending represents the outright cost of resolving failed institutions and the remainder is for working capital needs.  The FDIC’s impact on the federal budget is likely to grow as bank failures begin to mount.  Finally, we continue to look for the budget deficit to be US$425 billion in the fiscal year that ends in September.

* We forecast a 0.4% decline in overall retail sales in July and a 0.4% rise excluding autos.  Another sharp drop in motor vehicle sales should help to depress the headline result.  Elsewhere, the chain store sales results were mildly disappointing, so we have shaved our estimates for general merchandise and apparel relative to our preliminary expectations.  Meanwhile, the gas station category is likely to show another price-related advance – albeit at a more subdued pace than in recent months.  Finally, company reports point to a solid gain in the drug store category and a modest rebound for restaurants.

* Based on the results from the manufacturing and wholesale sectors, it appears that overall business inventories posted a very sharp 0.9% gain in June.  However, sales were up even more, so the I/S ratio is likely to tick down to 1.23.

* We look for the consumer price index to rise 0.5% overall in July and 0.2% ex food and energy.  Prices at the gas pump finally started to pull back a bit during July, but the seasonal adjustment factor actually anticipates a somewhat larger decline at this time of the year.  So, we should see another jump in the energy category, led by gasoline and household fuel.  Meanwhile, the core is expected to just barely round down to +0.2%, with some moderation in shelter and softness in vehicle prices helping to offset upside in airfares and apparel.  Also, the large hike in cigarette taxes that helped to push up the tobacco category in June should not come into play this month.  If our July estimate is close to the mark, the year-on-year rate for the core should hold at +2.4%.

* We expect industrial production to be flat in July.  A weather-related pullback in utility output should help to restrain the headline production reading this month.  Meanwhile, the labor market data point to a second consecutive 0.2% rise in the key manufacturing component.  Gains in motor vehicles, high-tech and aerospace are expected to lead the way this month.

Central Europe
ULC Headaches
August 12, 2008

By Pasquale Diana | London

Unit Labor Cost (ULC) growth has picked up sharply in Central Europe, presenting serious macro threats. Labor market tightness has translated into faster wage gains across the whole region. Productivity, while remaining healthy, has been unable to keep up with the pace of wage hikes. This has translated into faster unit labor cost growth, now running in double-digit territory in Romania, and in stably positive territory in Poland, the Czech Republic and Hungary. In this note, we look at ULC in industry, for two reasons: i) they can be tracked on a monthly basis; and ii) productivity in services is notoriously hard to estimate. Faster ULC growth threatens macro stability in two related ways: it increases inflation pressures, and it makes the country less attractive for FDI, eroding its cost advantage. We analyze each in turn.

Inflation: ULC Gains Underscore Core Pressures

Much has been said lately about the coming drop in headline inflation due to the related slowdown in non-core components: food CPI should ease due to improved harvests this year, and energy CPI is expected to drop sharply on account of the recent drop in oil prices as well as some powerful base effects. While we share the view that headline inflation is at, or close to, peak everywhere and is set to fall (except in Poland, where a ‘second peak’ is possible in 1Q09), we think that the core inflation outlook is less clear-cut. Looking at the last three years, the countries in Emerging Europe that have seen the largest rise in core inflation are also the ones that have experienced the fastest ULC growth.

In Central Europe, the uptrend over the last two years is pretty uniform: year to date, ULC growth stands at 15% in Romania, 6% in the Czech Republic, 6% in Poland and 1% in Hungary. IP growth is slowing everywhere in the region, and given its cyclical nature, productivity growth will slow as well. If wage growth does not slow in sync, then ULC growth is set to move even higher, and pressures on core inflation might remain strong even if headline CPI is easing. The key therefore is wage behavior.

The acceleration in wage growth seen across the region is due to a combination of factors: i) strong labor demand, as firms expanded output; ii) weak labor supply, as participation rates remain below the EU average and a number of people left the region to work in Western Europe; and iii) high wage demands, to compensate for the recent surge in inflation. Understanding how these factors play out is key to gauge where wage growth is likely to go. Overall, inflation pressures should ease next year, labor demand should slow, and there are reports of workers returning home from Western Europe. So, all in all, these wage pressures should ease. However, the risks to this view appear to be firmly skewed to the upside: wage growth might remain stubbornly high, as inflation perceptions and expectations might remain stuck at the new, higher level; also, some of the labor shortages (especially skilled workers) are structural in nature and will take several years to correct. Finally, the evidence of a return of workers to their native countries is still patchy at best. Overall, the combination of slower productivity gains and only modestly lower (but rather sticky) wage inflation will mean that ULC costs will continue to accelerate into next year.

Faster ULC gains need not translate into higher prices. Firms may choose, especially if they operate in a competitive environment, to absorb the rise in ULC and accept lower margins. As the National Bank of Poland has repeatedly noted in its statements, strong financial results of enterprises (i.e., profits) may curb inflation pressures in the medium term, as firms do not need to raise prices. We do not have good data on profits from across the region, but at least in Poland that argument looks less and less persuasive. Aggregate profits remain elevated, but appear to have peaked (the year-on-year change has gone to zero).

Competitiveness: Still Cheap, but for How Long?

Investment incentives, competitive tax rates and lower labor costs have attracted significant FDI flows into the region over the last few years. Eurostat data show that compensation levels in Central Europe stand at 20-40% of euro area levels, up significantly from 2000 but still relatively low. When we try to correct for productivity levels, lower than in Western Europe, the cost advantage is smaller, but still substantial.

For foreign firms that invest in Eastern Europe, what matters is not just labor costs, but also labor costs expressed in their domestic currency (overwhelmingly the euro, in this case). Given sharp appreciation of most CEE currencies, ULC growth expressed in EUR has shot up recently, especially in the Czech Republic and Poland.

It is too early to argue that future FDI inflows are at risk, but it is also true that ULC growth, coupled with this pace of FX appreciation, will ultimately spell trouble for these economies, if sustained. There is already anecdotal evidence on the ground of firms trying to link wages to the exchange rate (i.e., pay at least part of the salaries in euros).

Conclusion

The acceleration in unit labor cost growth increases the risk that core inflation grinds steadily higher (or stays elevated), even as headline inflation slows due to base effects. This means that central banks across the region will err on the side of caution in running monetary policy, even as growth slows. We think that the NBP will hike rates once again this year, but then leave them unchanged across our forecast horizon (as will the CNB, after this week’s rate cut). The NBH and the NBR will both ease policy rates next year, but in a gradual and cautious fashion. Sharp currency gains put competitiveness at risk and, as the CNB has shown in rather dramatic fashion lately, central banks might become more uneasy with fast appreciation as growth risks intensify.

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Brazil
Commodity Challenge – Choose Your Poison
August 12, 2008

By Marcelo Carvalho | San Paulo

The market’s mood has soured a lot in recent weeks, amid fears of nasty commodity price declines and a US dollar rally. What are the implications for commodity-exporting countries like Brazil? Weaker commodity prices can hurt Brazil’s growth performance and its balance of payments. By contrast – and perhaps ironically – a rebound in commodity prices could rekindle inflation concerns, and thus might intensify Brazil’s monetary policy response. Choose your poison. Commodity prices can go up or down. Either way, we suspect that the end result will be slower real GDP growth in Brazil. 

What Drives Brazil’s Export Prices?

Swings in the US dollar and global growth seem to be important drivers for international commodity prices. Indeed, our own econometric exercises suggest that moves in the US dollar against a basket of other main currencies can go a long way in explaining moves in Brazil’s export prices measured in dollar terms, with a time lag of about a year. Whatever the theoretical underpinnings of this finding, the empirical relationship is too strong to ignore. 

Note that our focus here is on Brazil’s specific index of export prices, although its correlation with international commodity prices is unsurprisingly high. After all, about half of Brazil’s exports are commodity-related, ranging from iron ore and soybean to sugar and coffee. Our results appear consistent with recent findings in the economic literature, which suggest that exchange rates can be useful in forecasting commodity prices (see Kenneth Rogoff, Yu-Chin Chen and Barbara Rossi, Can Exchange Rates Forecast Commodity Prices? NBER working paper 13901, March 2008).

Dollar appreciation can weaken Brazil’s export prices, usually with a lag. The steady US dollar depreciation against a basket of other currencies in recent years has helped to support Brazil’s export prices. However, if our global currency strategists are right that the dollar has formed a multi-year bottom, then the recent dollar appreciation – if continued − would work to dampen international prices for Brazil’s exports.

Global growth deceleration can also hurt Brazil’s export prices, with an estimated lag of about two quarters. The long-run empirical relationship between global growth (as measured by the OECD leading economic indicator) and Brazil’s export prices is strong. However, a large gap seems to have emerged between the two variables since 2005, as Brazil’s export prices have increased faster than what global growth indicators alone might suggest. In all, looking ahead, our econometric exercise suggests that the global growth slowdown and US dollar appreciation can prove potent factors to depress Brazil’s export prices. 

Paradise Lost

The IMF foresees an average drop of 5.2% in non-fuel commodity prices in 2009, after an estimated average gain of 14.6% in 2008, according to its latest World Economic Outlook Update, published in July. True, the Fund’s forecasting track record is far from impeccable. But let’s work with this working hypothesis for a moment. To put things in context, such a drop would come after several years of repeated, double-digit growth in commodity prices. Indeed, even after falling next year, the IMF’s non-fuel commodity price index would still remain almost 90% above where it stood in late 2002, at the start of the recent multi-year abundance rally. Likewise, Brazil’s export prices at mid-year have more than doubled from their level in late 2002.

A sustained fall in non-fuel commodity prices would likely drag along Brazil’s export prices too. In fact, the long-run historical relationship between these two independently constructed series is high, with a simple correlation coefficient of about 60% over the past couple of decades.

What would a decline in commodity prices mean for Brazil? Brazil’s growth performance is more strongly correlated with Brazil’s export prices than is often recognized. Whatever the specific transmission channels are, the actual empirical relationship is nothing short of remarkable. The simple correlation coefficient here is about 75%, and the two variables seem to be simultaneous, with no apparent time lag between them.

If history is any guide, a plunge in commodity prices would seem to have the potential to slow Brazil’s growth back to a crawl. The years around the turn of the decade had been tough for Brazil. By contrast, in retrospect, the years since 2003 have been paradise. Going ahead, we suspect that such paradise is lost: the global environment facing Brazil in the coming years will likely prove less supportive than it has been over the last five years.

Indeed, the bulk of the upturn in Latin America’s performance since 2003 has come from external factors – the hand that the region has been dealt. For Brazil, according to our econometric exercise, the estimated average boost to annual growth from the terms-of-trade improvement accounts for much of the improvement in growth between 2003 and today (see “Latin America: Growing Disconnect, Growing Risk”, EM Economist, March 7, 2008).

Falling commodity prices can hurt Brazil’s trade picture too.  In fact, Brazil’s export prices in the 12 months through mid-2008 jumped 18.5%, while growth in export volumes came to a halt in the same period. Meanwhile, imports have grown fast, rising 43.7% in the 12 months through mid-year, with rising import prices (17.0%) as well as import volumes (22.8%). Brazil’s trade surplus is shrinking fast in 2008, and can easily vanish in 2009. While 2008 is mainly a story of import strength, 2009 may prove to be a story of export weakness, under a global growth slowdown that might simultaneously weaken Brazil’s export prices and volumes. In turn, a weaker balance of payments could eventually challenge the strength of the real.

In sum: be careful what you wish for. Falling commodity prices can bring important relief for the global inflation picture. However, the accompanying implications for Brazil’s growth and balance of payments are worth bearing in mind.

Abundance in Overdrive?

One risk to the scenario described above is ‘abundance in overdrive’, as our chief economist for Latin America, Gray Newman, argues (see “Emerging Markets: Latin Hawks versus Global Doves”, EM Economist, July 25, 2008). What if the recent decline in commodity prices turns out to be a premature alarm? The global slowdown might take longer to really dent commodity prices in a sustained way. This could be especially true if Asian central banks (including India and China) turn their policy priorities towards preserving growth rather than fighting inflation.

If ‘abundance in overdrive’ stays for longer, two implications may entail. First, risks might increase for a hard-landing scenario later on, at least for those economies that try to buy growth at the cost of higher inflation. This could muddle the global growth outlook for 2010. Second, global inflation pressures might re-ignite. Without the helping hand of slower growth and commodity markets, and until central banks around the globe embark on sufficient monetary tightening, global inflation concerns would remain an issue.

In turn, persistent global inflation pressures could force the hand of Brazil’s central bank to tighten more than otherwise. Indeed, Brazil’s central bank is committed to bringing inflation back to the 4.5% target center in 2009. And it judges that insufficient global monetary tightening is no excuse for monetary policy complacency in Brazil. The longer global inflationary pressures persist, then the stronger will be Brazil’s monetary policy response.

After all, Brazil’s central bank seems on a mission to slow the economy from the current above-potential pace. The central bank aims to reduce the mismatch between domestic supply and demand, and thus to minimize the risk that localized inflation pressures contaminate broader inflation dynamics. Brazil’s central bank does not seem to count on global growth deceleration to save the day. To the contrary, if global conditions remain inflationary, Brazil’s central bank seems willing to respond strongly enough to leave no doubt about its commitment to keep domestic inflation under control. 

Choose Your Poison

The last five years were exceptionally favorable for commodity exporters like Brazil. Global growth was unusually strong. International commodity prices increased steadily, and global inflation was remarkably low. But that picture is changing now, as the era of abundance appears to be coming to an end.

Looking ahead, commodities prices can increase or fall: either way, Brazil is unlikely to sustain the rapid growth seen until recently. Choose your poison. If ‘abundance in overdrive’ regains ground, then rebounding international commodity prices could rekindle inflationary pressures. In response, Brazil’s central bank would likely act to cool down its overheating economy and keep Brazil’s inflation under control. Instead, if commodity prices head further south amid the global growth slowdown, then history suggests that Brazil’s growth performance will suffer. With or without help from global conditions, the end result will likely be slower domestic growth in Brazil.

Bottom Line

Declining international commodity prices, amid a US dollar rally, hurt Brazil’s export prices. This, in turn, tends to slow Brazil’s economy, if history is any guide. By contrast, if commodity prices rebound, then inflation concerns could resurface. Brazil’s central bank would respond firmly, tightening monetary policy as much as necessary in order to slow the economy and keep inflation under control. Choose your poison. Commodity prices can go up or down. Either way, the end result is clear: Brazil’s growth seems destined to slow.

 

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