Last week, the Standard & Poor's Ratings Services downgraded Brazil's sovereign debt into junk territory. What does it imply for the global economy and gold market?
We have been warning that the recent appreciation in the U.S. dollar and decline in commodity prices would hit many emerging markets (but not only them, as Canada demonstrated lately, entering into recession), especially those producing raw materials. We focused on Russia, whose economy continues to struggle as the price of oil remains low, however we also mentioned occasionally the ongoing crisis in Latin America.
The recent developments in Brazil are an excellent pretext to take a look at the eight largest economy in the world (by the nominal GDP, or seventh by the GDP adjusted by purchasing power). The country entered officially recession, as its economy contracted 1.9 percent in the second quarter of this year, following a 0.7 percent decline in the first quarter. Actually, the ‘slumpflation’ should be better description, as the Brazil’s inflation rate simultaneously increased from 7.14 in January to 9.53 in August. And the real, the Brazilian currency, has plummeted more than by one-third against the U.S. dollar over the past six months, reaching its lowest level since December 2002. In consequence (and due to the negative outlook for the second half of 2015 and 2016), the S&P downgraded the Brazilian government’s sovereign debt rating to junk status. Unsurprisingly, the gold price expressed in the real has been rising over the first half of the year (see the chart below).
Chart 1: Gold price in Brazilian reals (per ounce) over the past year
What are the reasons behind the Brazil’s recession? In short, the slowing of economic growth in China and the end of the commodities boom hurt the economy. Without the external stimuli the illusionary growth based on government spending and easy monetary policy had to collapse. Investors should not also forget that the two largest economic crisis in Latin America in the last 60 years occurred after the two largest periods of Fed’s loose monetary policy (at the beginning of 1980, and in 2009, after the subprime crisis), thus the current problems partially result from the anticipation of the Fed’s interest rate hike later this year and the resulting appreciation of the greenback (this is because Brazil’s companies loaded up on tremendous amount of debt denominated in the U.S. dollar during the boom times).
What are the possible consequences for the global economy and the gold market? Well, we should expect outflows from Brazil into the U.S. dollar, which should exert some downward pressure on the price of gold. On the other hand, the Brazil’s recession is another signal that global economy is slowing down. The slower growth in the world could drag down also the U.S. economy, being more reliant on global trade than even before, which would be positive for the yellow metal.
The key takeaway is that Brazil entered a technical recession and the S&P downgraded its investment grade to junk status. The slump in Brazil, as in Russia and Canada, reflects the global turbulences due to anticipation of Fed’s hike and the slowdown in China. Brazil is eight (seventh) economy in the world, so the potential negative spillovers should be positive for the gold market, however the rising greenback may be a headwind for the yellow metal.
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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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