Brazil's Inflation Risks Resurface

Jul. 08, 2018 8:22 AM ETEWZ, BRZU, BZQ, UBR, DBBR, FBZ
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There are positive signals for global growth transmission, but also new emerging markets-specific risks.

The June spike in Brazil's inflation (see chart below), bringing it to 4.39% year-on-year, was completely predictable as it came on the heels of the truck drivers' strike. As such, we are unlikely to see an immediate policy response from the central bank, though there are several risk factors to watch going forward. A sharp increase in the diffusion index1 (to an estimated 65.5%, the highest since early-2016) shows that the price pressures were widespread. There are also potential second-round effects associated with the past weakness of the Brazilian real (down 18.6% since March). It is, therefore, hardly surprising that markets continue to price in 52bps of tightening for August-September.

The first round of U.S. tariffs on USD34B of China's goods went into effect today. This was expected - as was China's reciprocal move - hence a very muted market reaction. The next USD16B round of tariffs should kick in two weeks later, giving the market plenty of time to focus on China's macro releases - including the international reserves release this weekend. The reserves are still large in absolute terms, but their adequacy had eroded to the point that they are no longer sufficient according to one of the four metrics used by the International Monetary Fund. The consensus expects only a tiny reserves' decline in June - any negative surprises might place China back on the list of potential emerging markets risks.

Markets reacted with a risk-on rally to the U.S. labor market report, which was surprisingly strong given the economy's place in the business cycle. The non-farm payrolls beat consensus at 213K (which means an accelerating year-on-year growth rate!), while an uptick in the unemployment rate to 4% was most likely due to a higher participation rate. Overall, this is a good set of numbers as regards to the global growth transmission mechanism (including emerging markets), but there are still no signs of inflation/wage pressures.

Chart at a Glance

TBrazil Inflation

Source: Bloomberg LP

1 Diffusion index is a measure of the degree to which different indicators change in the same way over a particular period of time.


PMI - Purchasing Managers' Index: economic indicators derived from monthly surveys of private sector companies; ISM - Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI - Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI - Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation - Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI - Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX - CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM - JP Morgan's Government Bond Index - Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments.; EMBI - JP Morgan's Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan's Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.

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