Brazil's Weakening Industrial Output, And The Real

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Includes: EWZ
by: Andrew Sachais

Summary

Factory activity in Brazil is contracting.

Rising inflation led to higher borrowing costs, cutting off growth.

As Brazil's economy weakens further, its currency should similarly decline.

Industrial output is weakening in Brazil as business confidence declines, weighing on the price of the real. Brazil's currency is represented by iShares MSCI Brazil Capped (NYSEARCA:EWZ).

In May, the industrial output figure came in at an annual pace of -8.8% contraction, below the previous month's reading of -7.6%, while bettering estimates for -10.2%. After reaching levels exceeding 20% growth in 2010, factory activity has steadily weakened, seen below. High borrowing costs have weighed heavily on business spending activity.

"Industrial confidence in Brazil has risen from a record low as [President Dilma Rousseff]'s government takes steps to fortify fiscal accounts and pushes a $64 billion program of infrastructure investment.

While industry faces the highest borrowing costs since 2009, a weaker currency helps make the country's exports more attractive," according to Bloomberg.

Moreover, as the government attempted to balance its budget, inflation has skyrocketed. In May, the inflation figure came in at an annual pace of 8.47%, above the previous month's reading of 8.17%, while also exceeding estimates for 8.32%. Since 2010, inflation has risen by nearly 400 basis points, seen below. Rising inflation has forced policymakers to tighten conditions, weighing on economic activity.

"The inflation rate accelerated for the fifth straight month, reaching the highest value since December of 2003.

The inflation has been on the rise since January when the government initiated a number of austerity measures and tax increases aiming at balancing overall budget. The new taxes have raised the prices of basics like electricity, bus fares and gasoline.

The government has been trying to fight inflation by increasing the borrowing cost. In fact, since September of 2014, the Selic overnight lending rate was raised by 275 basis points to 13.75 percent," according to Trading Economics.

Finally, business confidence has plummeted under the regime of President Rousseff. In June, the business sentiment figure came in at 38.9, above the previous month's reading of 38.6, while also bettering estimates for 38.5. A reading below 50 signals pessimism. Since reached a high of nearly 70 in 2010, sentiment has halved, seen below.

Brazil's economy continues to freefall. Factory activity and investment have rapidly declined as inflation spiraled higher, alongside rising borrowing costs. With the level of uncertainty currently surrounding Brazil's economy, its currency should further weaken in coming months.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.