FX Weekly Summary (Brazil Issue)

On Friday (15), the USDBRL ended the session with a daily drop of 0.5%, quoted at BRL 5.433. As previously mentioned, the release of better-than-expected results of the June monthly retail sales survey and the consumer survey for July, both for the United States, helped to alleviate pessimism regarding the US economy and contain upward pressure on the dollar during the session. However, the depreciation seen during the day was not enough to erase the strong gains of the US currency throughout the week, which increased by 2.6% compared to the previous Friday (8) and accumulated a high of 3.3% in the month.

With the global situation predominating over the oscillations of the FX markets, the dollar index, which measures the strength of the American currency against a basket of currencies from advanced economies, accumulated a weekly rise of 1.0% and closed quoted at 107.9 points, very close to its highest levels in the last 20 years. The strengthening of the index was largely due to the dollar's appreciation against the euro, bringing the exchange rate down to USD 1.00.

Foreign Scenario

Global markets rallied this week on higher-than-expected Consumer Price Index (CPI) and Producer Price Index (PPI) data in the United States, which confirmed the acceleration and spread of inflation across the various items that make up both the US consumer basket and the costs of the country's manufacturing sector. 

Data from the Bureau of Labor Statistics (BLS) showed a 1.3% advance for the Consumer Price Index (CPI) in June, significantly above analysts' projections of 1.1% and exceeding the 1.0% rise seen in May. With the result, the accumulated figure for the last 12 months, which jumped from 8.6% in the previous month to 9.1%, reached its highest value since the end of 1981. Meanwhile, the Producer Price Index (PPI) pointed out that producer prices increased by 1.1% in June, which was above the median of the agents' estimates of 0.8%. Accordingly, the accumulated rate for the last 12 months was 11.3%, above the 10.7% expected by the market, reaching the fifth consecutive month of double digits for the indicator and renewing the historical series' highs.

In addition to heightening fears of stagflation in the world's largest economy, the update of the price indices realigned the agents' outlook regarding the Federal Reserve's monetary policy action, consolidating the understanding that the moment would be ripe for an intense monetary contraction to tackle the acceleration in inflation. Up until the beginning of the week, the debates about the next decision of the American central bank, which will take place on July 27, revolved around a possible increase in the same magnitude as that seen in June, when the basic interest rate was raised by 75 basis points, the biggest adjustment since 1994.

After the surprise of the indicators and statements from Fed members, reinforcing the firm stance of the monetary authority in the fight against rising prices, the market's perception is that the decision at the end of the month will certainly include an increase of at least 75 basis points, with part of the agents considering the possibility that the Fed may raise the interest rate by up to 100 basis points.

As of last Friday (15), the agents' positions in future interest rate contracts pointed out that around 69% of market participants bet on a 75 basis points hike in the basic US interest rate to a range between 2.25% and 2.50% p.a. In comparison, 31% believe that the central bank will raise the basic rate by 100 basis points to a range between 2.50% and 2.75% p.a.

The liquidity tightening and the increase in credit costs in the main global financial centers will have important repercussions for the rest of the world, particularly affecting developing economies and worsening the situation of those already having external imbalances and a high dependence on imported goods and services.
 

China

China's National Bureau of Statistics (NBS) reported that the Chinese economy shrank by 2.6% between April and June from the previous quarter, a stronger drop than projected by analysts, who expected a -1.5% change. This was the first negative result since the 6.8% drop in the first quarter of 2020, the start of the Covid-19 pandemic, and reflects the measures adopted by the country's tough zero-Covid policy, which promoted mass lockdowns in April and May to control a new increase in virus infections. In addition, the isolation of a significant portion of the population from important industrial and financial centers, such as Shanghai, drastically reduced the movement of people and sacrificed the level of activity in industry and services during the period. As a result, as analyzed in the China Direct daily report, produced by StoneX's Market Intelligence team in Shanghai, Chinese industrial production recorded a 3.9% growth in June, slightly below expectations of a 4.1% increase and significantly below the 8.3% recorded in the same month a year earlier. Thus, signs of weaker activity in the second largest global economy raise concern when the world is dealing with fears of a global recession. 

The NBS data for China's trade balance in June corroborated this scenario, falling short of the expected for imports, which registered a growth of only 1.0%, slowing down from May (+4.1%) and staying below the analysts' projections (3.9%). The signs that China will maintain slower growth in the coming months may put downward pressure on the prices of mineral and energy commodities, besides being concerning for Brazilian exports since the country is with a large advantage Brazil's main trading partner.

Traders should continue to monitor the evolution of Covid-19 cases in the Asian giant following the discovery of the new subvariant BA.5.2.1 of the omicron variant in China. According to experts, this new strain is more contagious. It has a greater potential to evade the immune response of people who are immunized or have already had the disease, accentuating the chances of new lockdowns being adopted in the country. Last Thursday (14), the country reported 432 new Covid-19 infections, up significantly from 292 the day before and the highest number of cases in one day since May 25.

Eurozone

The energy vulnerability of the Eurozone economies was put in the spotlight this week with the interruption of natural gas supplies from Russia to Germany due to the maintenance of the Nord Stream 1 pipeline. With relations between Western Europe and Vladimir Putin's government strained since the invasion of Ukraine, the reopening of the pipeline later this month and the gas flow that the Russians will supply is still uncertain. Until the maintenance stoppage, the volume transported by Nord Stream 1 was 60 percent of normal, which was already helping to keep natural gas costs significantly lower than in other consuming regions such as the United States. In the very short term, Europe suffers from strong heat waves and does not depend on the energy source for heating. With the approach of the coldest months of the year, the risks of rationing, suspension of activities and strong pressure on the purchasing power of families are expected to grow substantially. 

The formation of expectations about the slowdown in the eurozone economies and the impacts of the developing energy crisis will be complemented with new information this week, with the publication of the consumer inflation data, the monetary policy decision of the European Central Bank (ECB) and the PMI forecasts. 

On Tuesday (19), the European Union's statistics agency, Eurostat, will release the Harmonised Indices of Consumer Prices (HICP) for June. The median estimates point to a 0.4% increase in the indicator's core monthly comparison - slowing down from May - and maintenance of the accumulated over 12 months at 4.6%.

ECB officials will meet this week and update the monetary policy parameters for the eurozone economies on Thursday (21). In general, it is expected that on June 9, the reference interest rate will show a 25 basis points increase. However, some market participants are betting on the possibility of a more intense adjustment of 50 basis points to face the inflation that has exceeded the target of 2.0% p.a. 

The risks of a deepening energy crisis, economic slowdown and new shocks to the price level may narrow the window for interest rate adjustments. Suppose a firmer response from the ECB this month, taking advantage of the remaining time to maintain a contractionary stance. In that case, euro quotes could be favored, recovering some ground lost against the dollar in recent weeks. However, compliance with the guidance given in June tends to take precedence, prioritizing the credibility of the monetary authority's communication and postponing a 50-point increase to the September decision.

On Friday (22), previews of the PMIs for the eurozone's manufacturing and services sector for July will be released. Economists' projections are for slight decreases in both indicators compared to June, with the manufacturing PMI dropping from 52.1 to 51.0 points and the services PMI going from 53.0 to 52.0 points. However, despite the drops, the consensus is that both sectors still do not show contraction in activity levels, remaining above the 50-point threshold that separates retraction and expansion.

Domestic Scenario

In Brazil, the week was marked by the Chamber of Deputies' approval and enactment of the proposed constitutional amendment (PEC) of income transfer programs. The PEC creates several benefits less than three months before the elections, with an estimated cost of BRL 41.25 billion, which does not respect the spending cap rule or provide any counterpart on the revenue side and is considered by the market as a lack of government commitment to the country's fiscal framework. The Minister of Economy, Paulo Guedes, stated in a press conference that fiscal policy remains strong and that the income transfers promoted by the proposal will have no net fiscal impact. According to the minister, an extraordinary government collection of BRL 57 billion, through tax gains and dividends from state-owned companies, will be enough to cover the cost of the PEC.

The Ministry of Economy (ME) released its revised estimates for growth and inflation in 2022, adjusting its outlook for economic growth from 1.5% in the previous projection to 2.0%, raising the Gross Domestic Product to BRL 9.725 trillion (nominal). However, for the National Broad Consumer Price Index (IPCA), estimates were reduced, incorporating the impact of legislative measures on fuel and electricity prices, taking the accumulated over the last 12 months until December this year from 7.9% to 7.2%. 

The ME also reaffirmed through a statement its "commitment to the fiscal consolidation necessary for the continuity of the economic recovery scenario" when echoing the change in the evaluation of the credit rating agency Fitch, which improved the outlook for Brazil's long-term sovereign credit rating from "negative" to "stable." Despite keeping the country's credit rating at "BB-," according to Fitch, there was a significant reduction in public debt in 2021, with projections that 2022 will show another slight decline, considerably improving the starting point before a gradual increase projected for 2023.

The calendar for domestic indicators and the National Congress – in recess – is empty this week, with the market having to keep an eye on the political news and the electoral scenario having more importance in investors' expectations. According to the calendar of the Superior Electoral Court (TSE), from Wednesday (August 20) to August 5, "party conventions will be allowed to deliberate on coalitions and choose candidates for the presidency of the Republic and state governments, as well as federal, state and district deputies. The period will be decisive for the definition of candidates and alliances between parties, with the parties, federations and alliances having until August 15 to request the registration of candidates, which will allow the market to visualize more clearly the possible scenarios for the October elections.