Monday digest
Posted 9 October 2023
Overview: Recession fears return
The balmy autumn temperatures have continued into October, but September’s market chill has also carried through and that is more troubling. Continuing the recent trend, last week saw a further rise in global long bond yields, despite some weakness signals from the global economy. The 10-year US Treasury benchmark hit a yield of 4.88% in early trading on Tuesday – its highest yield in 15 years. Other government bond markets duly responded, although rose slightly less. Yields subsequently fell back over the week but crept back towards their highs after another extremely strong US jobs report on Friday (with 336,000 new jobs reported). Because of the inverse correlation between yields and bond valuations, this meant a fall in in the global bond index price of about 1.5%. Global equity markets also fell, but mostly due to the valuation impact of rising bond yields rather than pessimism over economic growth and any impact on earnings.
While there is no denying that the forecasts for a slowdown this year have proved wrong – in the US and even here in the UK, market volatility has shifted up across all asset classes which suggests global market liquidity is getting tighter – not surprising, given the continued drain by central banks and the substantial losses across bond markets and, to some extent, commodity markets. Tighter financial conditions make it more likely that growth will slow so we suspect that, in themselves and just like with oil, higher bond yields now probably mean lower bond yields later.
For equity and credit markets, it may be that bond yields plateau and then fall without too much impact. However, the tightening of liquidity is not a helpful signal and the risks of a sharper bout of volatility are clear. Ahead of the next round of rate meetings, central bankers could make things worse if their comments were seen as hawkish. However, inflation data is likely to be helpful rather than a hindrance, so we should perhaps expect them to sound slightly dovish in the next few days and weeks. We certainly hope so.
Brazil’s new era
As the ‘B’ in ‘BRICS’, South America’s largest economy naturally has a lot of growth potential. Like many of its emerging market (EM) neighbours, it also has a bit of an unstable reputation. Many investors would ascribe to it all the regular EM hallmarks: high inflation, corruption and currency woes. South American countries also have a particular reputation for political frailty, fiscal excess and debt crises. That said, Brazil’s economy has never come close to the chaos of its hyperinflation crisis of the late 1980s and early ’90s, where inflation topped 70% month-on-month for the first three months of 1990 and took seven years to stabilise. From 1990 to 1994, it had four different national currencies rolled out in a series of unconventional and mostly unsuccessful plans to stem the crisis. But the Brazil of today is markedly different.
Like most countries, Brazil saw prices rise as it came out of the pandemic, but its inflation rate peaked in early 2022 and has come down considerably since. In fact, Brazil’s consumer price index (CPI) inflation rate has been below the UK’s every single month for more than a year, touching a low of 3.16% in June. Its government debt is fairly well contained too. Again, pandemic-era emergency spending forced an increase in the country’s debt-to-GDP ratio, but the spike was much smaller than comparable jumps in the UK and US. Improvements have not come at the expense of growth either. GDP growth has come in above 2% in all but one quarter since Q2 2021, the exception being a respectable 1.9% expansion in the last three months of 2022. Its most recent figure of 3.4% in the three months to June 2023 is impressive enough on its own, but even more so when one considers the broader global economic headwinds, as global demand has slowed and supply become tighter.
After last October’s presidential election, where Luiz Inácio Lula da Silva was elected for a third term at the expense of Jair Bolsonaro, the transition from far-right Bolsonaro to left-wing Lula was expected to be difficult and potentially violent, but in the end was remarkably smooth, all things considered. In particular, there was no significant Trump-style insurrection attempt, and Lula has proven surprisingly effective at pulling the different political factions together for compromise. Even fears that Lula would loosen fiscal policy dramatically, worsen inflation and send bond yields skyward failed to materialise. In fact, Lula’s recent rhetoric has been remarkably controlled – backing the balanced budget pledge and fiscal reduction targets of his under-pressure finance minister Fernando Haddad. In the spring, Brazil’s 10-year yields fell from above 13.5% to below 11%. And while these have risen since, the step up has been closely in line with global bond market moves.
This is helping Brazil to be seen as a viable investment destination. Despite a challenging third quarter for global stock markets, Brazil’s stock market is up 12.3% over the last six months in local currency terms. Its currency has not fared too poorly either – losing recently against the dollar as all global currencies have, but by no more so than the euro, for example. It is very likely that Brazil has been a beneficiary of western investors’ exodus from Chinese assets this year. And in terms of trade reconfiguration, Brazil might end up being one of the biggest beneficiaries of US decoupling attempts from China – as Mexico has been to this point.
Undoubtedly, the fiscal control on public spending and monetary control on private debt growth comes at a cost and the next two quarters will feel substantially less ‘growthy’ to most Brazilians. This will test Lula’s popularity and may bring pressure to ease. Of course, if global growth comes under significant pressure, an easing in one or both may be warranted. But, while policy inevitably must be responsive, there is a growing sense that the path is one of stability and that could make this feel like a new era. Certainly, the world needs a politically and economically stable Brazil. Brazil is no longer the risky country it once was, and it is in everyone’s interest to make sure it never is again.