Today, the Brazil's central bank is likely to raise its key interest rate, the SELIC as discussed in the January newsletter. Analysts estimate a 50 basis point hike. If this occurs, it will place short-term rates at 11.25%. The global inflation trend is driving this decision, as food and energy costs have hit Brazilian consumers particularly hard over the past several months.
On the other hand, raising rates threatens to create another inflationary force through the carry trade as foreign banks and other institutions flood even more capital into the nation to take advantage of these rates. The problem is that foreign capital has been responsible for artificially inflating the Real. As you can imagine, this has not hurt Brazil's very important export trade.
Brazilian Real to the U.S. Dollar
While Brazilian officials have made several attempts to reduce the influx of foreign capital, thus far these efforts have not worked. One cannot expect to raise taxes for a couple of percentage points for foreign capital and reduce this influx when rates are over 11%.
All of this also has implications for China, as Brazil's number one trading partner. If Brazilian exports become more expensive, it's only going to increase the cost of Chinese exports to the U.S. The result is that China will be forced to let the Yuan float more freely in order to cushion the effects of inflation. With a stronger Yuan, exports to the U.S. will be more costly, and this will hit the wallet of U.S. consumers.
China has been facing its own share of related problems. Since November, China has raised bank reserve requirements four times. As well, it's raised interest rates twice since October 2010.
As capital continues to flood into China, inflation is beginning to take a toll on consumers, with food, energy and transportation being hit particularly high. Newsletter subscribers will recall how I discussed how food costs make up a much larger percentage of the inflation index used in China.
Based on these macroeconomic trends, I would not expect the recent gains in consumer spending to continue in coming months. As you can imagine, this will ultimately affect the U.S. stock market. Certainly I'm not talking about a market crash due to this situation alone. However, it adds just one more road bump for the market to continue its bullish run.
Through the Federal Reserve's reckless monetary policy, global inflation continues to increase. Meanwhile, banks from advanced nations are helping to increase inflation in developing nations through their quest for easy profits via the carry trade. There can be no happy ending from all of this.
For now, it would appear that the Real will set new year-highs versus the dollar, with the Yuan not far behind.
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