Thursday, August 1, 2013

Brazil's central bank under pressure as demand for resources slows and foreign capital exits

Brazil is facing a situation not to dissimilar to India (discussed here). In order to stem the recent currency declines, the central bank (BCB) has raised the benchmark rate.

Unfortunately raising rates at this stage in the cycle is absolutely the wrong thing to do for Brazil's economy - although given the currency declines BCB had little choice. Brazil's economy is facing serious headwinds and higher rates will not help. The nation's manufacturing is starting to contract again. According to HSBC,  "the loss of momentum observed in recent months evolved into an actual weakening of economic conditions, with negative implications for the next quarters."

Source: Markit

Unlike the situation in India however, Brazil is also struggling with declining demand for natural resources (see post), particularly given its economic ties with China. The trade surplus the nation has enjoyed for years is beginning to erode.

Source: Credit Suisse (* CS forecast)

While the official unemployment rate remains near the lows, consumer surveys are pointing to weakening labor markets.

Source: JPMorgan

Because of deteriorating economic fundamentals and ongoing flight of capital, some of which is due to surprisingly broad and persistent social unrest (see post), the currency hit a new multi-year low against the dollar. BCB's recent efforts to stem the declines are proving unsuccessful thus far.

USD/BRL (real per one dollar; source:

While this is a wish come true for Brazilian exporters, the central bank is obviously uneasy with such currency weakness and may need to take further action. Moreover, with the Australian dollar weakening sharply as well (see chart), competition from Australian mining firms will increase. Brazil's central bank is facing some daunting challenges, as the bubble, driven by China's insatiable appetite for resources and record low rates in the US, has finally burst.
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