Itaú BBA - The end of a strong-dollar cycle

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The end of a strong-dollar cycle

August 7, 2020

The global recovery continues, while in Brazil fiscal risks remain high.

Please open the attached pdf to read the full report and forecasts.

Global Economy
Global recovery to continue, weak USD could last longer
We expect the global recovery to continue, as vaccines advance and developed economies avoid fiscal cliffs. We raised our GDP growth forecasts for the Euro Area to -7.0% in 2020 and 6.0% in 2021 (from -8.0% and 5.0%, respectively), and for China to 2.3% in 2020 (from 2.0%). For the U.S., we maintained our estimates at -5.0% in 2020 and 4.0% in 2021. We believe the weak USD environment may last for a while, but vulnerabilities in Latin America will likely prevent the region from fully benefiting.

Firmer stabilization
There are signs that the spread of the virus is stabilizing. Easing of social isolation did not increase the number of daily deaths, which allows for some recovery in economic activity, consistent with maintaining our forecast of -4.5% for GDP growth in 2020. Fiscal risks remain high, with pressures to increase social spending. Even so, we revised our exchange rate forecast to BRL 5.25/USD in 2020 (compared to 5.75 previously) reflecting the more benign global scenario for risky assets.

Latina America
Our Forecasts


The end of a strong-dollar cycle

New cases of coronavirus seem to be peaking around the world, the outbreaks are becoming less lethal and vaccine developments are advancing – meaning normalization will likely continue, even if there are short-term speedbumps along the way. However, recovery will probably unfold in a assymetric fashion, as developed economies face fewer constraints than in the emerging markets, especially in
Latin America, where the fiscal cliffs will constitute a key challenge once the health crisis has been dealt with. But even amongst avanced countries, differentiation is bound to take place, with better growth in Euro Area than in the U.S., not only because the first is already at a more mature stage of the oubreak (still with a few localized surges, but better prepared to trace and isolate new hotspots), but also because of strenghtened policy coordination in the region, more notably on the fiscal front. At the margin, European data (and Chinese, for that matter) are printing better than expected, leading us to revise 2020 growth expectations to the upside, in both cases.

In this context, the USD appears to have ended an appreciation cycle that was driven by an outperformance of its home economy when compared with the rest of the world. The COVID-19 pandemic has likely put a halt to this trend, but with a falling growth differential and a brighter policy outlook in Europe, the dollar may remain weak for longer than just the immediate aftermath of the crisis. The polls showing Democratic candidate-to-be Biden ahead in the race for the oval office also contribute in this direction, as his economic agenda of higher corporate taxes favors a weaker USD.

However, emerging markets, and Latin America in particular, are not benefiting much from this environment. Although external accounts are improving in the region, infection rates are still high, delaying the recovery and widening fiscal imbalances. Furthermore, the health crisis puts institutions and policy frameworks under stress. In Brazil, there is a growing debate over how to spend above the expenditure-cap ceiling. In Chile, Peru and Mexico, populist measures are moving forward in Congress. Finally, in Colombia, the fiscal rule was recently suspended, and the prospects of necessary reforms to retain the investment grade status are poor (the recent arrest of former President Uribe certainly doesn’t help to improve the political climate). Thus, although we are improving our FX forecasts for the region due to the external scenario, our forecasts still imply a meaningful weakening against the USD, when compared with year-end 2019.

In Brazil, there are signs of stabilization of the outbreak. The decrease in social isolation has not led to more daily deaths, and allows for continued recovery of economic activity, consistent with maintenance of our -4.5% forecast for GDP growth in 2020. Fiscal risk remains high, with pressures to increase social spending, which should go up in 2021, creating a pressure on public accounts that should be partially offset by a higher tax burden. Although the risks around this scenario are an important source or concern, we revised our exchange rate forecast BRL 5.25/USD in 2020 (from 5.75) reflecting (exclusively) a more benign global scenario. We also reduced our inflation forecast to 1.7% from 1.8%, due to surprises with recent data. For the next year, we maintained the projection at 2.8%, but we reinforce that this estimate has a downward bias. In this context, we expect the Copom to maintain its extraordinarily stimulative stance, with the Selic rate at 2.0% pa, throughout this year. In the medium term, however, the current fiscal deterioration raises important doubts about the sustainability of this low interest rate environment.


Global Economy
Global recovery to continue, weak USD could last longer 

We expect the global recovery to continue in 2H20 as vaccine studies move forward and developed economies avoid fiscal cliffs.

We revised our Euro Area GDP estimate to -7.0% (from -8.0%) for 2020 and to 6.0% (from 5.0%) for 2021. For China, we revised it to 2.3% (from 2.0%) for 2020, and for the U.S. we maintained our estimates at -5.0% and 4.0% for 2020 and 2021, respectively.

Weaker USD could last longer this time. We revised our Euro estimate to 1.25 to the dollar from 1.15 and our CNY projection to 6.85 to the dollar from 7.00 for the end of 2020.

Latin America: vulnerabilities prevent the region to fully benefit from weak global dollar environment.


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