Brazil: The Hunt for Red October

Brazil: The Week Ahead - The Hunt for Red October

Marcelo Carvalho - Market Economics
Brazil: The Week Ahead | 09 Nov 2012 16:30 |

You may have seen the film. The 1990 movie “The Hunt for Red October” is a thriller adapted from the Tom Clancy novel of the same name. In the story, Red October is the name of the new Soviet submarine that sonars are unable to detect. Sean Connery plays the commanding officer of the boat. Currently in Brazil, bearish forecasters seem to be hunting for a red October on growth data.

September was in the red. We know already that industrial production in September was weak, down 1.0% m/m. Next week’s remaining data for September will likely be soft too. Retail sales (to be released on Tuesday) will likely be close to flat or even slightly negative in month-on-month terms. More importantly, the real GDP monthly proxy (IBC-Br, due out on Wednesday) will likely be poor, as well, and in negative terrain for the monthly comparison.

The temptation to look for a red October is understandable, given the soft September data. It is easy to extrapolate September’s weakness into expectations about October. However, that would be a mistake. September’s slide in industrial production came after a jump of 1.7% in August. In addition, apparent weakness in September might be in part related to an imperfect seasonal adjustment for unusually fewer working days this September. In fact, partial and preliminary indicators available so far, such as energy consumption and car production, suggest that activity in October bounced back to positive terrain.

Do not be fooled by apparent softness in the September figures. We read them as near-term downticks in an otherwise clear recovery trend, as opposed to the start of a new, double-dip downturn. The underlying trend is up, not down. After all, 525bp of rate cuts since August 2011 will spur the economy. Monetary policy works. As always, there are time lags, but the impact from rate cuts on the economy is cumulative. Real rates have fallen to 2% now from 7% a year ago – that’s a lot of easing. In addition, fiscal and credit easing is on the table too: The authorities now officially recognize that they will not meet the fiscal targets this year, and the government is openly pushing commercial banks to cut their lending spreads and public-sector banks are lending aggressively.

Our strong out-of-consensus call is that the macro picture in Brazil will be very different in six to nine months. The main market theme in 2012 has been the softness of the economy, and how much the central bank cut rates as a consequence. The theme in 2013 will be how strongly the recovery will push inflation upward – and what this means for monetary policy. Market concerns about the “growth drag” in 2012 will be replaced by worries about the “inflation dragon” in 2013, we think. Our 2013 inflation forecast has long been highest on the street, by far. In turn, we believe high inflation will force the central bank to hike more (and earlier) than people expect (see “Latam interest rates: Take a hike in 2013”).

In all, while September figures were in the red, do not hunt for a red October – you will not find one.