The risk-averse behavior in financial markets around the globe this year — together with the upward movement of short and long-term interest rates both in Brazil and abroad —generated a strong deterioration in financial conditions. The effects on the economic activity have not been strong so far, given that measures adopted by the government and the process of reopening the economy have boosted growth in the short term. But the impact is likely to be felt in the second half of the year.

ASA Investments’ Financial Conditions Index (FCI) is close to the maximum since records began, in 2009. Several times this month, it beat the record of 2.28 of April 8, 2011 — on the 9th of this month, it reached 2.44. This Monday, it showed a slight accommodation, to 2.13, but still at a very high level.

The indicator combines price components (commodity indexes, oil prices and exchange rates) and market variables, such as national and international stock indexes, as well as the behavior of interest rates in Brazil and overseas. When they are negative, financial conditions are expansionary – favorable to the economic activity. When they are above zero, they indicate tight conditions, that is, contractionary.

“The trend seen since last year is a reversal [of financial conditions]. At the end of 2020, the indicator reached the negative minimum and began to reverse with quite impressive speed in the direction of the contractionary territory. At the beginning of this year, it was still negative and was advancing quite a bit [until reaching the positive field],” said Leonardo França Costa, an economist at ASA Investments.

The main movement towards the contractionary territory was oil prices, which skyrocketed since the beginning of the war in Ukraine, says Mr. Costa. In addition, the Brazilian and international interest rates have risen sharply since the beginning of the year. While the 10-year interest rate is around 3% in the United States, the return of the 10-year German Bund already exceeds 1% — much higher levels than those seen at the end of last year. In Brazil, almost the entire yield curve is around 12%.

Given the movement to higher interest rates around the world, equity markets have suffered this year, which also helps to tighten financial conditions.

Analysts, however, evaluate that the financial conditions may reach even higher levels, given the ongoing monetary tightening in the United States, which could affect Brazilian economic activity, especially in the second half of the year.

From a quality point of view, there has been a worsening in almost all the most common components of financial conditions this year, said Leonardo Porto, Brazil head economist at Citi. Besides interest rates and the global stock markets, he highlights the behavior of country risk, measured by the five-year Brazil Credit Default Swaps (CDS), which is around 230 points against 205 at the end of 2021 at the same time that the Volatility Index VIX, considered Wall Street’s “fear barometer,” also rose strongly.

“These are variables that point to tighter financial conditions that hurt economic activity. So far, all of them are heading in the same direction, of turning the financial conditions indicator into a more restrictive one throughout this year”, he says. According to Mr. Porto, the only factor that has helped contain an even more restrictive environment is the strong performance of commodities, important for an exporter country like Brazil.

Still, the economic activity seen in the GDP to be released on Thursday, however, is likely to show acceleration. The median of the projections collected by Valor indicates a 1% growth in the first quarter and 1.4% for the whole year 2022, while two weeks ago, the market expectation was that the GDP for this year would be around 0.8%. The expectation for the 2023 GDP fell to 0.7% from 0.9% on May 12.

Eduardo Yuki — Foto: Ana Paula Paiva/Valor

“We had some temporary effects, which helped the activity in the short term,” said Eduardo Yuki, executive superintendent of macroeconomics at Safra. He cites the positive performance of the soybean harvest at the beginning of the year and government programs, such as the payment of the salary bonus moved ahead, as well as the year-end bonus called thirteenth salary, for retirees and pensioners, and the authorization to withdraw money from Workers’ Severance Fund (FGTS).

“All of this helps the activity in the short term. The point is that, if you bring forward factors such as the bonus and the thirteenth salary, you won’t have them up front and, when the end of the year comes, we will have two effects together, since those payments were moved ahead and we will see the impact of the financial conditions more strongly,” warns Mr. Yuki. Safra believes that the economy is expected to have a much more moderate performance in the second half “and, for this reason, we have a view that an important part of what happened to the activity was supported by temporary effects,” the economist said.

He does not see room either for a big relief in financial conditions ahead. To the extent that the policy interest rate Selic rate may rise to 13.25% and remain around 13% for quite some time, in Safra’s view, the economic activity throughout 2023 will also be affected.

“Our perspective, looking at how the indicator is constructed, is that it will tighten a little more. One of the premises is precisely in global conditions, because we know that the U.S. Federal Reserve has a cycle of interest rate increases to make. This could tighten financial conditions in the U.S. and, consequently, ours as well. So, the contractionary territory is expected to remain,” Mr. Yuki says.

For the Safra economist, next year could start with a modest performance around the globe, “precisely because of the need for the world as a whole to make a monetary tightening cycle to control price pressures.” Consequently, in Mr. Yuki’s view, this environment is likely to make Brazilian GDP grow below potential in 2023. “It is the pace that will help the disinflation of the economy over time.”

In the view of Santander Asset Management’s chief economist Eduardo Jarra, the tightening of financial and monetary conditions into the economy will be seen more intensely in the second half. He emphasizes that the current environment takes place at a level of risk aversion different from the one experienced in recent years and that the uncertainties that are already present in the scenario will remain, especially those related to inflation in the United States and the path of U.S. interest rates.

“It seems that we will carry those questions with us as the economy moves towards a more advanced stage of the economic cycle. The international environment will probably continue to be heavy and in Brazil the electoral environment in the second half will likely generate an increase in volatility,” points out Mr. Jarra.

Evaluating the scenario as a whole, the economist says he believes there is an indication of even tighter financial conditions in the second half. “We may see negative GDP readings in the second half [of 2022], and for next year we are expected to continue to carry over the effects of tight monetary policy,” he notes. For him, there may be a scenario in which the Selic only begins to be reduced in the second half of 2023. In addition, Mr. Jarra points out that, although the international scenario may become less uncertain, “it is still not a positive environment.”

Source: Valor International

https://valorinternational.globo.com