EM turmoil and Eurozone laggards

The meltdown in Brazil is not exactly unexpected since one of my ten surprises for 2014 was that Brazil goes into recession. But I find the pace of the currency reaction alarming and we should be prepared for a crisis as a result. In the developed economy, despite sluggish growth, I am generally positive on the near-term. France and Italy are the laggards to be concerned with.

So, as I woke up yesterday, the news was that Brazil’s currency had dropped to 3.10 reais to the dollar, a 11-year low. Yes, Brazil is in a recession and it is dealing weith a widening corruption scandal. But the pace of decline of the currency suggests panic and crisis. The latest I am hearing from Andy Lees at the Macro Strategy Partnership is that Brazil’s three biggest lenders are structuring an emergency loan to Brazil’s power utility companies, but only at higher yields and longer maturities. We’re talking BRL3.15bn which is just north of $1bn USD at present exchange rates. The problem: utilities became indebted due to what Andy calls “government-mandated reduction in power prices” in addition to the drought. Clearly utility rates are going to have to go up as a result, and that’s going to be negative for inflation and consumer spending.

This is just another headache. Clearly Brazil is falling apart right now and these are the kinds of deals that get done in this environment. I don’t think Brazil is an isolated case of maxcro mismanagement. I believe it is a harbinger of emerging market turmoil that will return in 2015.

In the developed economies, I am fairly upbeat. In particular, I see the eurozone headed in the right direction economically. But there are laggards. Finland has been poor and Austria has banking problems. But to my mind, Italy and France are the worries because they are so-called periphery countries who need to benefit from euro weakness and the general uptick in economic fortunes in Europe. Yet, Italian industrial production fell 0.7% in January, marking the largest decline since September. Markets were anticipating a 0.2% increase. Italian industrial production is now down 2.2% year-on-year. The good news is that France, which had been a laggard here saw industrial production rise 0.4% in January, while analysts were expecting a drop of 0.3%. Since IP was also up 1.4% in December, that shows a nice back-to-back rise in French numbers. But France is just bumbling along as the chart from Pantheon Macroeconomics below shows

My take: Europe is not out of the woods. Outside of Greece, the economy is getting better and we should expect capital markets to benefit. But the numbers out of Italy tell you that Greece is not the only problem.