1. From Brexit to Brazil

    Sally Greig, Investment Manager. Second Quarter 2018
  2. Brazil has the UK, and Scotland in particular, to thank for their introduction to the beautiful game. In April 1894, the first football match in Brazil was organised by an ex-pat Scot, Thomas Donohue. Six months later, the first Brazilian football club was set up by Charles William Miller. The rest, as they say, is history.

    These days, Brazil and the UK may be miles apart in terms of footballing prowess, but the countries do at least share one surprising commonality: a 3% inflation rate. For two countries that had diverged so much post the 2008 financial crisis, we are now back to square one which is important because inflation is a crucial concern for any bond investor, whose income can be eroded by high inflation.

     

    Annual Rate of Inflation

    Source: Bloomberg and underlying index provider(s).

  3. Playing football at sunset on Ipanema beach, Rio de Janeiro, Brazil.
  4. From a UK Perspective

    The past few years have not been the UK’s finest, especially when it comes to politics. Having failed to quieten the Euro sceptics within his own party and secure the country’s vote to remain in the European Union, the Prime Minister David Cameron immediately announced his intention to resign; once in office, his successor Theresa May, tried to shore up her position by calling a snap general election. This too backfired, resulting in a hung parliament. And with the clock ticking down to ‘Brexit’ in April 2019, British negotiations have yet to secure much in the way of progress from their European counterparts.

    Add to this the well-known structural issues affecting the UK economy – an overvalued housing market, a large current account deficit and, currently, one of the highest inflation rates in the developed world – and you begin to see why all three of the large rating agencies have taken away the country’s prized AAA credit rating in the past five years on concerns over the challenges ahead.

     

     

    Image: A mural by street artist Banksy depicting a European Union flag being chiseled by a workman in Dover. © Bloomberg/Getty Images.

  5. The Brazilian Perspective

    If politics have been a dampener on UK prospects for economic growth in recent years, Brazilian politics have been on the up following the impeachment of its President, Dilma Rousseff and the demise of her government in late 2016. Since then, the new president, Michel Temer, has shown that he is determined to improve the long-term sustainability of his country’s public finances. He has introduced a freeze on government spending, and is pushing through pension and labour reforms to tackle Brazil’s deep-rooted welfare state and high levels of unemployment. We think this positive policy trajectory is likely to remain, whomever wins the upcoming presidential elections in October this year.

    Like the UK, Brazil has its structural challenges, but it is in a much more comfortable position having emerged from its worst-ever recession on record in 2015–2016. This recession, in part triggered by the collapse in commodity prices in 2014, crushed domestic demand. The consequent reduction in imports helped to improve Brazil’s trade balance and has made it easier for the Central Bank to reduce domestic interest rates, on the back of faster-than-expected falls in inflation. With lower interest rates and improving confidence, growth has improved to 2.1% and is expected to rise further.

     

     

    Image: Famed mural painted by artist Eduardo Kobra for the Rio 2016 Olympic Games on May 12, 2017 in Rio de Janeiro. © Getty Images South America.

  6. Are imbalances correcting?

    A country’s current account balance is an important indicator of the nation’s economic health as a measure of the country’s savings and spending in the same way that our bank account balance might provide some insight into our personal finances. While both the UK and Brazil are currently in deficit, the changing fortunes of the two are perhaps best illustrated in the chart below, with Brazil’s deficit showing a notable correction since the recent recession.

     

    Current Account

    Source: Oxford Economics.

  7. Brazil has responded to the challenges it has faced through a reduction in consumer spending and a higher level of savings. As a result, it should be much less vulnerable to external shocks in the form of rising US interest rates and a change in global investment flows.

    On the other hand, the UK has yet to correct its spending imbalance. Its current account remains uncomfortably negative and has been so for more than a decade. So much so, that is now larger than that witnessed before the last major UK recession in the early 1990s, when London house prices fell over 30% and the pound suffered a significant devaluation. The low savings rate and high levels of household borrowing in the UK has kept consumption levels high, and the country remains vulnerable to external shocks.

    Times have been tough for Brazil, but maybe now its time for the UK to toughen out a rebalancing?

  8. IMPORTANT INFORMATION AND RISK FACTORS

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  9. Sally Greig

    Investment Manager
    Sally graduated MA in Economics and Statistics from the University of Edinburgh in 1998 and also gained an MSc in Finance and Econometrics from the University of York in 2003. Prior to joining Baillie Gifford, she worked at the Bank of England from 2001 as an economist in the Foreign Exchange Division, and provided regular analysis to the Monetary Policy Committee. She joined Baillie Gifford in October 2005 and is an Investment Manager in the Rates and Currencies Team.