LCA Weekly Macro View: Global and domestic markets resilience to uncertainties will be put to test only in 2018

LCA Weekly Macro View: Global and domestic markets resilience to uncertainties will be put to test only in 2018

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Chamber Member News Post Date: 11/08/17 Source: LCA Consultores By: LCA Consultores
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Summary

The US Dollar has regained some ground in the last few weeks, as expectations for tax reform have brightened somewhat. The chances of a tax reform approval have indeed risen, but the Trump-GOP proposal still faces a lot of resistance - especially from "fiscal hawks" - that should extend negotiations through the end of the year.

On the other hand, as expected, the appointment of Jerome Powell as the next FED chairman had no great impact on global markets, as it reinforces expectations of continuity of the gradual monetary policy normalization successfully implemented so far during Janet Yellen's term. As a result, the Treasury curve continued to flatten: the 10year-2year government bond spread, for instance, has fallen to the lowest level since November 2007.

In our view, the bond markets may be underestimating the pace of policy normalization by the FED in 2018. The US economy has been gaining traction and inflation (of wages and prices) should begin to reflect tighter labor market conditions. Besides, upcoming changes are expected to turn the FOMC's composition somewhat more hawkish.

We don't expect the FED to embark on a tightening spree. But we do expect the FED to raise interest rates three to four times next year, as opposed to current market expectations of only two rate hikes in 2018. This should, thus, lead to moderate adjustments in market expectations in the medium term, with equally moderate impact on the demand for emerging market assets - one of the reasons why we expect a moderate depreciation in the Brazilian currency next year.

Besides a less favorable external environment, a clouded political scenario ahead of the 2018 elections can put some additional pressure on our exchange rate next year - as political uncertainties are putting at risk the macroeconomic adjustments necessary to rebalance the fiscal accounts and bring the public debt dynamics under control.

In these circumstances, we don't expect the Brazilian Central Bank to extend the current monetary easing cycle into next year. The monetary policy stance is already accommodative; and the inflation trend for next year is expected to be far less favorable than in 2017. Our forecast for the official IPCA inflation rate for 2018 has been revised from 4.3% to 4.5% - due to greater uncertainties regarding energy prices.


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