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Saturday, October 04, 2008

Brazil's Economy Enters The Eye Of The Storm

by Edward Hugh: Barcelona

Brazil is in the middle of a storm at the moment, there can be no doubt about that. But the important point to note is that this storm is not of Brazil's making. The shock waves which are currently traversing all of Brazil's financial and banking institutions (as well as its real economy) are a reflection of a much broader "terremoto" which is erupting in all the major financial centres across the globe, from New York to London, to Frankfurt and on to Tokyo. And of course, when the developed world sneezes, it is the emerging markets who tend to catch the cold. So let's all just hope that this is all it is that the patient is suffering from at this point, a common or garden cold, and that we don't have an early case of pneumonia on our hands. Menawhile, botton down the hatches, since a hurricane is about to pass.

Response to the Crisis

Brazilian President Luiz Inacio Lula da Silva today authorized Brazil's central bank to buy loans from cash-starved banks and indicated the governments willingness to use the country's international reserves to ease a credit crunch that sent the Brazilian real to its lowest in two years and the stock markets right down. As part of the coordinated response to the crisis the central bank sold $1.36 billion in dollar swaps this morning, offering the contracts for a second straight day in an attempt to slow down the surging demand for dollars in the foreign exchange market. The bank sold 27,400 contracts of 46,050 on offer. On Monday the bank sold $1.47 billion of swaps, the first auction of the contracts since May 2006. The real gained more than 1 percent (to 2.176 per U.S. dollar) shortly after the sale of the swaps. The real plunged 7 percent yesterday.

The central bank has also announced it may also lend dollars to Brazilian institutions abroad. The government is also going to provide the state development bank with an additional 5 billion reais ($2.29 billion) to finance exports. The measures ``are important steps to shield the Brazilian economy from the impact of the international crisis,'' Meirelles told reporters.

Authorities are seeking to shore up confidence after Brazil's Bovespa benchmark stock index yesterday plunged to the lowest in 19 months, leading losses in emerging markets along with Russia. The Brazilian real dropped 6.2 percent as commodities, which account for about two-thirds of Brazilian exports, fell. Last week the central bank eased rules on reserve requirements for a second time in the same number of weeks to make more cash available for the banking system.

Stock trading was halted twice yesterday, for the first time since 1998. Trading was stopped after the Bovespa index dropped more than 10 percent at the open and then more than 15 percent in midday trading. The central bank sold $1.5 billion worth of currency swap contracts, the first sale of the kind since May 2006, to stem the real's losses. Brazil's currency has lost 21 percent in the past month against the dollar.

As a further indication of the extent of the present problem, the Brazil government today canceled a local bond sale. This was the first time this has happened in seven months, and offers a further sign of how the global credit crisis is beginning to squeeze Brazil's liquidity.

The Treasury shelved an auction of inflation-linked bonds, known as NTN-Bs, as the tumble in the real appeared to throttle demand for local assets. The Treasury had not announced the quantity of bonds it planned to sell.

The yield on Brazil's overnight futures contract for January 2010 delivery increased 28 basis points, or 0.28 percentage point, to 14.75 percent. The yield on Brazil's zero-coupon bond due in January 2010 rose 33 basis points to 14.88 percent, according to Banco Votorantim.

Emerging Market Bonds

But Brazil is not alone in being hit in this way, and emerging-market bonds had their worst week in four years last week as the deepening credit crisis raised global recession concerns and slammed the brakes on demand for higher-yielding securities. The extra yield investors demand to own developing-nation bonds instead of U.S. Treasuries has surged 109 basis points, or 1.09 percentage point, since the start of last week and reached 4.88 percentage points today (Tuesday), according to data from JPMorgan Chase and Co. The increase is the biggest since at least May 2004 and left the so-called spread at its widest since June of that year. The spread has swelled 1.89 percentage points since the end of August.

Until credibility is restored, we will not see people investing. Investors at this point seem to be unwilling to take any sort of visible risk. The cost of protecting developing nations' bonds against default rose considerably yesterday. Five-year credit-default swaps based on Argentina's debt soared 231 basis points yesterday, reach to 15.09 percentage points, the highest since the country restructured defaulted debt in 2005. That means it costs $1.509 million to protect $10 million of the country's debt from default. Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

Emerging Market Stocks

Emerging market stocks fell the most ever yesterday (Monday) and exchanges in both Brazil and Russia were forced to halt trading as the global banking crisis escalated in Europe and oil dropped below $90 a barrel. Brazil's Bovespa index was down 12 percent, while Russia's Micex Index dropped 19 percent after trading was halted three times. China's benchmark CSI 300 Index also fell 5.1 percent, its biggest one-day decline since August. The MSCI Emerging Markets Index slumped 11 percent, the biggest intraday loss since 1987.

This followed a week in which emerging-market stocks had the biggest weekly decline in seven years, led by banks and energy companies as commodity prices dropped on speculation the U.S. is headed for a recession. The MSCI Emerging Markets Index dropped 2.3 percent to 741.73, after a 3.4 percent decline yesterday. The index lost 10 percent this week, the most since the September 2001 terrorist attacks.

Brazil's Stocks

Trading on the Bovespa was halted twice yesterday as stocks tumbled 5,452.81 points to hit 39,064.51 at 1:50 p.m. New York. The Bovespa has now declined 36 percent in the past 30 days, and the index is now the world's worst performing major equity index in North and South America this year, down 51 percent on a currency-adjusted basis, after being the best-performing major market until June. Brazil's real plunged 6 percent against the dollar and Mexico's peso tumbled to a record low.

Emerging market stocks are now taking a severe hit after posting an annualized gain of 32 percent over the past five years as oil prices rose and commodities rose with oil hitting a record $147.27 and the Reuters Jefferies Commodities index reaching an all-time high in July. Brazil is the world's biggest producer of coffee, orange juice and sugar, and about half of Brazil's Bovespa index is constituted by raw material producers.

Central Bank Eases Reserves

Brazil eased requirements on reserves that banks must keep at the central bank for the second time in two weeks at the end of last week in response to worsening credit conditions sparked by the international financial crisis. The central bank now allows banks to meet up to 40 percent of their reserve requirements on time deposits by acquiring credit portfolios from other financial institutions. The measure is expected to free up to 23.5 billion reais ($11.6 billion) that are currently kept as government bonds deposited with the central bank, it said.

Interbank rates have soared as financial institutions worldwide hoard cash to meet future funding needs amid deepening concern that more banks will collapse. Governments in Europe and the U.S. rescued six financial institutions in the past week. The measure is ``intended to improve resources distribution in the national financial system in response to liquidity restrictions seen in the international market,'' the Brazilian central bank said.

On Sept. 24, policy makers delayed the introduction of higher rates for mandatory deposits from leasing companies by two months and raised the threshold on exemptions for cash, time and savings deposits. The measure added 13.2 billion reais to the financial system.

September Global Manufacturing PMI Shows Sharp Contraction

September seems to have been the ultimate "mensis horribilis" for industrial output internationally - and thus it is only natural to assume that Brazilian industry was also adversly affected - with global manufacturing activity contracting for the fourth consecutive month, and output falling to its weakest level in over seven years according to the JP Morgan Global Manufacturing PMI, which at 44.2 hit its strongest rate of contraction since November 2001, down from 48.6 in August (Please see the end of this post for some information about countries included and the JP Morgan methodology).

According to the JP Morgan report the retrenchment of the manufacturing sector mainly reflected marked deteriorations in the trends for production, new orders and employment. The declines in output and new work received were the second most severe in the survey history, while staffing levels fell at the fastest pace for over six-and-a-half years. The Global Manufacturing Output Index registered 42.7 in September, well below the 48.5 posted for August.

The sharpest decline in production was recorded for Spain, followed by the US, Japan and then the UK. Although the Eurozone Output Index sank to its second-lowest reading in the survey history, it was above the global average for the first time in four months. Within the euro area, France and Spain saw output fall at survey record rates, while in Italy and Ireland the contractions were the second and third most marked in their respective series. Germany, which until recently was the main growth engine of the Eurozone, saw production fall for the second month running and to the greatest extent for six years. Manufacturing activity in Japan fell to the lowest in over 6- years with the Nomura/JMMA Japan Purchasing Managers Index declining to a seasonally adjusted 44.3 in September from 46.9 in August.

At 40.8 in September, the Global Manufacturing New Orders Index posted a reading well below the neutral 50.0 mark. JP Morgan noted that the trends in new work received were especially weak in Spain, the UK, France and the US, with the all bar the latter seeing new orders fall at a series record pace (for the US it was the strongest drop since January 2001). The downturn of the sector led to further job losses in September, with the rate of reduction in employment the fastest since February 2002. Conditions in the Spanish, the UK and the US manufacturing labour markets were especially weak.

Russian manufacturing shrank for a second month in September, and in so doing registered its first back-to-back contraction since November 1998, as companies cut jobs and growth in new orders slowed, according to the latest VTB Bank Europe Purchasing Managers Report. The PMI came in at a seasonally adjusted 49.8, compared with 49.4 in August. The August reading was the lowest figure in three and a half years, according to the bank statement. On such indexes a figure above 50 indicates growth while one below 50 indicates a contraction.

Manufacturing in China contracted for a second month in August, underscoring the risk of a slump in the world's fourth-biggest economy. The Purchasing Managers' Index was a seasonally adjusted 48.4, unchanged from July, the China Federation of Logistics and Purchasing said today in an e-mailed statement.

India's industrial output growth bounced back again in July (the last month for which we have official data), reaching a five-month year on year expansion rate high of 7.1%. This follows a noted slowdown where output only rose by 5.4 percent gain in June, and 4.1% in May, according to data from the Central Statistical Organisation.

But if we come to look at the manufacturing PMI we will see that India's manufacturing output has also slowed somewhat, and expanded at its slowest pace in 14 months in September according to the ABN AMRO Bank purchasing managers' index. The PMI reading - which is based on a survey of 500 companies operating in India - fell to a seasonally adjusted 57.3 in September from 57.9 in August. This reading was the lowest since July 2007. Still 57.3 still suggests Indian industry continues to grow quite vigoursly, although the report did highlight the fact that the drop in the index was mainly the result of a decline in growth of new orders, and implied a deterioration in demand conditions, both locally as well as in export markets.

So basically this is where we get to learn what a global credit crunch means in terms of output and economic growth.

Brazil's's Industrial Output Weakens Too

Brazil's industrial output fell a seasonally-adjusted 1.3 percent in August from July, the largest monthly drop this year. On an annual basis, output rose 2 percent, the slowest pace since March, according to data from the national statistics agency in Rio de Janeiro.

And the situation seems to have deteriorated further in September, since the headline seasonally adjusted Banco Real Purchasing Managers’ Index (PMI) registered a 25-month low of 50.4, down from 51.1 in August.

GM And Fiat Cut Vehicle Output

One symptom of the way the slowdown is hitting the real economy is the recent announcement by General Motors and Fiat Spa's Brazilian units to cut vehicle output in the country in October and November after asking some workers to take vacations early. Last week GM asked workers at three of its plants in Sao Paulo state to take time off beginning this month. About 1,700 of Fiat's 15,000 workers at their Betim plant will take at least 10 days of vacation.

Car producers are cutting production after four central bank interest rates increases pushed car-loan costs higher and weakened demand. Auto registrations rose 4 percent to 244,800 units in August, the slowest pace in two years, according to Brazil's Automakers Association. That compares to a 33 percent increase in July. Fiat says the decision will lead to a 10 percent decrease in the company's daily production of 3,000 units.

JP Morgan Global Manufacturing PMI Methodology

The Global Report on Manufacturing is compiled by Markit Economics based on the results of surveys covering over 7,500 purchasing executives in 26 countries. Together these countries account for an estimated 83% of global manufacturing output. Questions are asked about real events and are not opinion based. Data are presented in the form of diffusion indices, where an index reading above 50.0 indicates an increase in the variable since the previous month and below 50.0 a decrease.

The countries included are listed below by size of global GDP share, and the figures in brackets are the % og global GDP in each case (World Bank Data).

United States (30.5), Eurozone (18.7), Japan (13.9), Germany (5.6), China (4.9),United Kingdom (4.5), France (4.0), Italy (3.2), Spain(1.9), Brazil (1.9),India (1.7), Australia (1.3), Netherlands (1.1), Russia (0.9), Switzerland (0.7), Turkey (0.7), Austria (0.6), Poland (0.5), Denmark (0.5), South Africa (0.4), Greece (0.4), Israel (0.3), Ireland (0.3), Singapore (0.3), Czech Republic (0.2), New Zealand (0.2), Hungary 0.2.


MyInvestorsPlace said...

Informative article with insight.

Great charts. I have taken a printout to refer. Already referred your article a couple of times.

Actually where we really go? Are we in the edge of an abyss?

MyInvestorsPlace - trading, value, investing, forex, stock, market, technical, analysis, systems

Anonymous said...

Might be time for a new post discussing how the rest of the third world (led by Brazil) have begun blaming the US for their problems (despite the otherwise economic independence of Brazil).

Edward Hugh said...


"Might be time for a new post discussing how the rest of the third world (led by Brazil) have begun blaming the US for their problems"

well, apart from the qualifier that I might say "lead by Europe" I wouldn't not disagree, but then this type of thing is beyond my technical expertise (I am an economist, not an agony columnist), and at this point the show show, time is very pressing. Hope you enjoyed the post (and the analysis) I was able to write.