Is the end of the cycle in sight?
In this report we provide a brief review of the tendencies for inflation and GDP growth in 2018. Despite the projection for expansion of GDP, by around 3%, the GDP gap is still negative, and even with the real interest rate below its neutral level, inflation will converge to the target of 4.5%. However, the Central Bank has been stimulating the recovery not only by cutting the SELIC rate, but also through efforts to remove obstructions from the credit channel and reduce bank spreads. With clear signs now appearing of a rebound of fixed capital investments, we would not be surprised if the Central Bank, after cutting 25 basis points at the next COPOM meeting, ends the easing cycle.
Why, with this optimistic situation, does the yield curve have a positive slope even after Lula’s conviction was upheld by the Federal Court of Appeals for the 4th District (TRF-4)? The empirical evidence does not indicate the Central Bank has exaggerated in its stimulus dosage. On the other hand, on the fiscal side an effort of 5% of GDP would be necessary to put the country’s house in order (the difference between the present recurring deficit, of 3%, and the 2% surplus necessary to stabilize the debt/GDP ratio). Notwithstanding the fiscal picture, which is vexing to say the least, demand for Brazilian assets (as well as those of the large majority of emerging countries) remains strong, which has reduced the CDS quotations and kept the exchange rate relatively stable. The risk implicit in the slope of the yield curve comes from a combination of two factors: a larger increase than expected in the interest rate in the United States; and failure to make any meaningful progress in the fiscal adjustment.
It’s impossible to specify if and when these negative effects might occur, but it’s necessary to pay attention to the signs that can affect the performance of the Brazilian economy, especially in 2019.
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