Something is out of order

2024 caught us by surprise. If we look at the report we wrote at the end of 2023 with the outlook for this year, we will see that both we and other market analysts had a more positive view, and that is not quite what happened. We were negatively surprised in various aspects of our economy. The exchange rate came under more pressure, inflation rose, and the interest rate, which was supposed to end the year below double digits, will finish the year very close to 12% per annum, with expectations of rising even further. The only exception and positive surprise was economic growth, which, once again, was well above what the market projected at the beginning of the year (see table below). Understanding where we went wrong (in everything... nervous laughter) and trying to decipher what might happen from here on out will be the arduous task for economists over the coming months. Shall we?

‍

‍

The situation is so out of order that it feels like we are living through another pandemic. Not in the sanitary sense, but in the sense that everything seems messy, out of place, as we mentioned in the title of this report. Starting with the international scene. We have two ongoing wars—in Eastern Europe and the Middle East—and although they do not have a direct impact on our economy, they are events that affect the general world order, bringing uncertainty and volatility to financial assets. Furthermore, they affect the prices of commodities, which are widely traded raw materials essential to the global economy. To give you an idea, commodities account for more than 60% of our exports. In other words, we are affected by this geopolitical issue in some way, even if indirectly.

In addition, we will face challenges and fears regarding our two main trading partners—the US and China—both together, all mixed up, yet separate and at odds, and a possible new trade war. In the US, the big question from 2025 onwards will be the country's direction under the new president, Donald Trump. The expectation of an ultra-conservative and protectionist policy tends to favor the American economy (and only them), generating greater economic momentum (only for them), more inflation, and, consequently, higher interest rates. In short, that is the expectation, and the impact of this on emerging markets is pressure on exchange rates, which are already quite strained, it should be noted. It is worth remembering that today, both American inflation and interest rates are falling (see chart), and a reversal of this trend could indeed be quite bad.

‍

Added to this is the expectation of lower Chinese growth, which, mind you, dear reader... we are not talking about 1% growth, but something closer to 5%, which is still low for the great world power called China, accustomed to growing by an average of 8% each year (see chart). The slowdown in the Asian country's economic growth could have significant consequences for the global economy, increasing the risk of recession. For Brazil, lower demand from China—which is currently our largest consumer of agricultural and mineral products—for Brazilian goods impacts exporters and may limit our economic growth (though I am not sure if we are very worried about that; we will see later).

‍

If the disorder seems great when looking outward, when we look inward, we are not very well-organized either. As we mentioned at the beginning of the report, projections have been better. The inflationary picture is the most concerning, as it is what could trigger a cascading deterioration for other variables. Consumer inflation is currently running at around 6.0%, and expectations for 2025 and 2026 are not encouraging at all; both are above the target. As renowned economist José Roberto Mendonça de Barros well mentioned in a recent article, “the worsening of expectations in the economy is close to becoming a fait accompli.” Are we in for some difficult years ahead?

Remember that our exchange rate has already risen more than 20% since the beginning of the year, and there are no signs of improvement. A high exchange rate for a long time is synonymous with inflation; we have seen this in the not-so-distant past. In other words, the fact may indeed be coming to pass, and as a result, the Central Bank will be forced to raise the Selic rate even further (which is already high again), as market projections show. High exchange rates, inflation, and interest rates are the main ingredients for the projections of lower growth from next year onwards to materialize. So, it is hard to disagree with Mendonça de Barros's words. We have been more optimistic, it is true, but it seems the fuel of positivity is running out.

This is without even going into detail about the fiscal scenario, which we have commented on in other reports throughout the year, and which will still give us many reasons for future discussions and concerns. Today, besides not helping, it is hindering. In other words, 2025 is expected to be an even more challenging year, full of many uncertainties and a continuous and strange disorder, as if we were facing something that began to rise but was never completed. Or, continuing the lyrics of the song that gave this report its title: “here everything seems like it was still under construction and is already in ruins.”