Itaú BBA - Stable Selic rate becomes more likely

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Stable Selic rate becomes more likely

January 2, 2019

Copom keeps the Selic stable at 6.5%. Activity with weak results, but confidence advances. Bolsonaro takes office as president of the Republic

The Brazilian economy in December 2018

The Brazilian Central Bank’s Monetary Policy Committee (Copom) left the benchmark interest rate unchanged at 6.5% pa. Jair Bolsonaro took office as president of Brazil on the first day of January. Activity indicators were weak in October, but confidence indicators continued to advance in December. The unemployment rate remains on a slow downward trend and inflation remains low.

Copom keeps the Selic rate at 6.50%

The Copom decided to leave the base rate unchanged at 6.5% pa, as widely expected. But the statement brought important changes, all on the benign side for prospective inflation. First, the authorities’ forecasts in the baseline scenario, with a constant Selic rate at 6.5% pa and the exchange rate at 3.85 reais per dollar, are fully consistent with the target’s path in longer horizons: 3.7% for 2018 (versus a 4.5% target), 4.0% for 2019 (vs. 4.25%), and 4.0% for 2020 (vs. 4.0%). Second, in the committee’s eyes, the risk of a lower-than-expected path for inflation due to high spare capacity has increased, while the risk of frustration with the continuation of reforms and adjustments has diminished. Finally, changes in forecasts and risks seem to have been significant enough as to cause the Copom to remove the mention of a gradual stimulus withdrawal in case of deterioration of the inflation outlook and balance of risks. By and large, the statement is consistent with the view of low interest rates for long in Brazil, and our own forecast of a stable Selic rate at 6.5% pa throughout 2019.

Jair Bolsonaro takes office as president of Brazil

The newly sworn-in president of the Republic, Jair Bolsonaro, began his inaugural speech in Congress with an appeal to lawmakers, seeking support in the fight against corruption, crime and economic irresponsibility. In the speech, Bolsonaro indicated that he will undertake initiatives to clash crime as a high-level priority, and that economic policy will be based on free market and respect for contracts. The new president said he will implement reforms aimed at ensuring the sustainability of public accounts, and signaled, still, its intention to open the domestic markets for international trade. The president also vowed to renew Brazil’s democracy, and concluded that foreign policy "will resume its role in defending sovereignty, building greatness and fostering Brazil's development."

Weaker activity data in October

Industrial production went up 0.2% mom/sa in October, printing below the median of market expectations (1.1%). Compared to one year earlier, output climbed 1.1%. After incorporating the October result, industrial output remains lower than before the truckers’ stoppage. The picture was ambiguous in terms of economic categories. Production of durable consumer goods and capital goods increased during the month (by 4.4% and 1.5%, respectively), but production of intermediate goods and semi-durable and non-durable consumer goods declined slightly (by -0.3% and -0.2%, respectively). In our view, the month’s weak performance reflects delayed effects of tighter financial conditions.

Core retail fell 0.4% mom/sa in October, extending September’s decline. Broad retail sales (including vehicles and construction material) retreated 0.2% mom/sa, disappointing the median of market expectations (0.6%). Five out of 10 broad retail components posted seasonally-adjusted monthly drops in October. Coincident indicators point to a 0.9% increase for the core retail sales in November, seasonally adjusted, and a 0.7% increase in the broad segment. Finally, real revenues from services rose 1.5% yoy, missing market expectations.

These reports allowed us to calculate the Itaú Unibanco’s monthly GDP, which climbed 0.6% mom/sa in October. From a demand standpoint, indicators that track gross fixed capital formation and household spending were stable on a seasonally-adjusted monthly basis in October. On a year-over-year basis, Itaú Unibanco’s monthly GDP accelerated to 2.1% from 0.8%.

Stable unemployment in November

According to PNAD Contínua, the nation-wide unemployment rate dropped to 11.6% in November from 11.7% in the quarter ended in October. Compared to the same quarter in 2017, unemployment slid 0.4 p.p. Using our seasonal adjustment, unemployment was unchanged at 12.1% in November. The breakdown between formal and informal jobs remains ambiguous. On one hand, PNAD figures suggest increases mainly in informal employment (in November particularly in self-employment using a corporate tax ID, the CNPJ) that offset declines in formal employment. On the other hand, the Ministry of Labor’s CAGED figures reflect gains in formal jobs since early 3Q18. In our view, this improvement will soon show up in the PNAD Contínua sample. Going forward, we expect the unemployment rate — under our seasonal adjustment — to recede to 11.6% by the end of 2019 and to 11.0% by the end of 2020.

58.7k formal jobs created in November

According to the Ministry of Labor’s CAGED registry, a net 58.7k formal jobs were created in November, beating market expectations. Seasonally-adjusted figures point to 82.5k new jobs in net terms during the month, the fastest pace since October 2013. The three-month moving average advanced to 71k from 63k. Breaking down by sectors, the four main categories posted gains (services, retail, manufacturing and construction). As in the October report, there are no signs that the improvement in the monthly pace of CAGED figures since July is related to changes brought in by the labor reform, as part-time and intermittent-time jobs represent less than 1% of all hired, and agreed layoffs represent 1.2% of all layoffs registered during the month.

Confidence indicators continue to advance in December

Confidence indicators published by FGV again showed positive results. Consumer confidence rose for a third consecutive month, by 0.6%, boosted by the subcomponent addressing current conditions (+3.2%), which offset the 0.8% slide in the item regarding expectations for the future. Confidence in the construction sector climbed for a fourth consecutive month, by 0.9%, and is up by 7.7% since August. In the same direction, confidence among retail entrepreneurs soared 5.7% to the highest level since April 2013. Confidence in the service sector advanced 1.4% to the highest level since April 2014. In the industrial sector, the increase in confidence was milder, at 0.5% in December, after remaining virtually stable in the previous month.

Inflation remains low

The consumer price index IPCA posted 0.21% deflation in November, printing below the lowest of market estimates (-0.17%, with the median at -0.09%). The mid-month IPCA-15 registered a 0.16% deflation in December, also somewhat below the median of market expectations (-0.12%). According to census bureau IBGE, it was the lowest December reading since the implementation of the Real Plan, in 1994. Hence, the index ended the year up by 3.86% (2.94% in 2017). Transportation (-0.18 p.p.), housing (-0.08 p.p.) and healthcare (-0.07 p.p.) posted negative contributions during the month, will falling prices for fuels, electricity and personal care items. In the opposite direction, most of the upward contribution came from food and beverages (0.08 p.p.), followed by personal expenses (0.05 p.p.). Our preliminary forecast for the headline IPCA in December is a 0.18% hike, ending the year at 3.78% (up from 2.95% in 2017).

Primary deficit of 15.6 billion reais in November

The consolidated public sector posted a primary deficit of 15.6 billion reais in November. The central government had a deficit of 16.2 billion reais, while regional governments had a surplus of 2.0 billion reais and state-owned companies had a deficit of 0.2 billion reais. The consolidated primary deficit accumulated over 12 months deteriorated to 1.5% of GDP in November from 1.2% in October. The latest monthly reading confirms the outlook for a better primary result than the target set for the deficit in 2018.

The general government’s gross debt increased to 77.3% of GDP in November from 77.0% in October, while the public sector’s net debt slipped to 53.3% of GDP from 53.6%. A favorable fiscal outlook depends strictly on the approval of reforms (such as the pension reform) that would signal a gradual return to primary surpluses that are compatible with structural stabilization of the public debt.

Financial assets

In December, the Ibovespa receded 1.8% in local currency and 2.1% in U.S. dollars, leading the yearly variation to +15% and -1.8%, respectively. Country risk measured by the 5 year CDS dropped 1-bp and ended the year at 209 bps. The exchange rate depreciated 17.1% in 2018 to 3.87 reais per dollar.

Upcoming events

Domestically, all eyes will be on discussions about the possibility of moving reforms forward, such as the pension reform, oil-rights transfers, funding to industry associations (the “S System”), among others, as well as the first decisions of the new administration, such as the trade opening and bureaucratic simplification measures.  

Overseas, trade discussions between the U.S. and China will remain on the spotlight.

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