Itaú BBA - Street Demonstrations and FX Depreciation Mark the Month

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Street Demonstrations and FX Depreciation Mark the Month

July 1, 2013

The real depreciated, because of higher U.S. rates, slow growth in China and domestic issues.

The Brazilian economy in June 2013

June was an eventful month. Protests against a hike in bus fares in São Paulo evolved into manifestations in several different regions in the country with diffuse demands, such as better public services, less corruption, improvement in government spending and a higher quality of education. As a response, the government reduced transportation fares and initiated discussions for a political reform. Recent polls show a decline in the government’s popularity, caused by the protests. The real depreciated, because of higher U.S. rates, slow growth in China and domestic issues. Monthly inflation moderated, but the weaker real will put more pressure on inflation going forward. The Central Bank signaled that interest rates will continue to rise. Consumer and business confidence retreated, but conditions in the labor market remain favorable.

Government responds to the population’s complaints.

The government took several actions in order to meet protesters’ demands. President Dilma Rousseff decided to send to Congress a proposal to convene a plebiscite, calling the population to vote on specific points of the political reform. Dilma also called for fiscal stability. All over the country, transportation costs (fares for buses, trains and toll roads) were reduced or programmed hikes were cancelled. In addition, the lower house rejected the PEC 37, a proposed constitutional amendment that would limit the power of federal prosecutors to investigate crimes. The PEC 37 was one of the main issues demonstrators were standing against.

The government’s approval rate declined.

According to a poll conducted by Datafolha, President Dilma's approval rating fell from 57% to 30%. The poll was conducted between Thursday and Friday last week (27-28 June) and captures the full effect of the protests that have taken place this month, differently from the previous poll, which took place in 6-7 June. The poll showed that voting intentions for Dilma also declined. In a scenario where the other candidates are Marina Silva (Rede), Aecio Neves (PSDB) and Eduardo Campos (PSB), Dilma is still the leader, but voting intentions fell to 30% from 51% in the previous poll.

Monthly inflation moderates.

June’s IPCA-15 inflation came at 0.38%, down from 0.46% in May. Annual inflation, however, rose to 6.69% (previous: 6.46%), following base-effects from a low reading in June last year (0.18%). Annual inflation will probably retreat in the second half of this year, but the depreciation of the FX rate is consistent with a higher inflation scenario than previously expected.

The Brazilian currency continued to depreciate…

The exchange rate had a very volatile month, depreciating to 2.22 reais per U.S. dollar by the end of the month. The move was partly caused by external factors. First, steadier growth in the U.S. suggests a stronger dollar. Second, the slowdown in China puts downward pressure on commodity currencies, such as the Brazilian real, the Australian dollar and the Chilean peso. But part of the depreciation in the real also reflects changes in domestic fundamentals, such as slower GDP growth, wider current-account deficit and an expansionary fiscal stance. On June 6, rating agency S&P revised Brazil’s long-term sovereign rating outlook from stable to negative. In order to contain the weakening of the real, the Central Bank has sold dollars through currency swaps and the Finance Ministry has removed all of the main capital controls implemented in the last two years.

…and the Central Bank may engage in a longer tightening cycle.

In its second-quarter inflation report, the Central Bank increased inflation forecasts for 2013 and 2014 and argued that the strengthening trend of the U.S. dollar adds risk for inflation. Still, the committee highlighted evidence that, according to its calculations, the pass-through of currency depreciation to inflation has declined in the last decade. The report did not signal urgency to accelerate the pace of rate hikes, but the unfavorable balance of risks and increasing inflation forecasts suggest that the tightening cycle may be longer than previously expected.

Confidence continues to decline, while unemployment remains low.

Both consumer and business confidence continued to decline in June, by 0.4% and 1.1% respectively. The results indicate slower growth in investment and consumption ahead. The unemployment rate, however, remains low, at 5.4% seasonally adjusted. Joblessness has remained close to this historically low level since July 2012. The average real wage and the real-wage bill ticked up in the month (both +0.1% mom/sa). The annual growth in the real-wage bill stands at 1.5%. Real wages are growing more slowly than in recent quarters, because of higher inflation and more moderate employment growth.

Stocks fall, risk spreads widen.

The benchmark Bovespa index extended its decline, falling 11.3% in June (-14.7% in dollar terms). The five-year CDS spread rose 26.2% during the month, to 186.7.

What’s next?

Protests have quieted down somewhat in recent days, but whether or not they will continue in coming weeks remains uncertain. The FX market is another key variable to watch, given the impact of a depreciation of the real on inflation.

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