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Brace yourself. Brazil is about to rock markets

NATANAELGINTING-FREEPIK

YOU MIGHT THINK the most important factors driving commodity markets right now are the speed at which the US Federal Reserve unwinds stimulus; the state of China’s real estate industry; or geopolitical jostling within OPEC. Don’t rule out the significance of Brazilian welfare payments.

Brazil’s currency, the real, has been trading around record lows in recent months, thanks largely to the President Jair Bolsonaro’s efforts to tear up a fiscal straightjacket and introduce an anti-poverty program ahead of elections in 2022. Laws that will allow the passage of the measures — a reboot of the Bolsa Familia cash welfare payment introduced by his predecessor Luiz Inacio Lula da Silva that Bolsonaro wants to raise to around 400 reais ($71) a month — have already cleared the lower house of congress and are now working their way through the Senate.

Politically, it’s a remarkable reversal. One of Bolsonaro’s central policies on coming to power in 2018 was a reform of the state pension system to plug budget deficits and regain the investment-grade credit rating Brazil lost in 2016. Winning back that investor confidence was the driving force behind the constitutional public spending cap that Bolsonaro himself is now abandoning to push forward with his own welfare program. Battered by the highest number of COVID-19 deaths after the US, Brazil’s commitment to fiscal restraint has become so threadbare that the career decisions of its more orthodox economy minister, Paulo Guedes, have become a market-moving indicator.

The broader global impact may be in commodity markets, though. Along with signs of easing in America’s supply chain crisis and Chinese energy prices returning to something approaching normal levels, the weakness of the real may yet help to ease the inflationary pressures coursing through the world economy.

That’s because Brazil has an outsize role in a wide array of the world’s essential foodstuffs and minerals. When the currency falls, production costs for Brazilian producers fall as well, making their goods more competitive and adding to supply.

Take soybeans, the country’s largest export, where US futures prices hit a nine-year high in May. Land typically accounts for about a quarter of costs for Brazilian soybean farmers, but — unlike fertilizers and pesticides, global commodities whose prices tend to move in tandem with the dollar — it doesn’t really rise in price when the real weakens. The same goes for spending on labor, tax, and other domestic expenses.

As a result, production in the current crop season is projected to hit a record of more than 5 billion bushels. Corn, whose futures prices also spiked back in May, is also forecast to see record output.

It’s a similar situation in meat. Brazil is the biggest exporter of chicken and beef and the third-biggest of pork, and all three are forecast to see rising production over the coming year, according to the US Department of Agriculture. Exports will total 2.66 million metric tons in the 2022 marketing year, the USDA reported this month, driving Brazil’s share of the global trade from around 18% in 2017 to 22% now. That may be just the start of it: cattle take several years to reach maturity, and the growth rate of Brazil’s herd is faster than that of its exports. Four out of five cows added to the global herd since 2017 have been in Brazil. That suggests further export expansion in the years ahead.

In chicken, the effects have been muted by the way that currency depreciation, pandemic, and inflation have hit living standards. Domestic chicken consumption has surged in recent years to replace beef calories that Brazilians can no longer afford. Even so, output will climb to 4.2 million tons next year.

Only iron ore among Brazil’s major commodity exports has fallen behind. Analysts expect output by state-controlled Vale SA will grow by about 20 million metric tons next year, but company forecasts may come in short of that when they’re presented later this month, Bloomberg News reported. Leading producer Australia will account for a larger share of output growth next year, and a faster pace, too.

The biggest commodity bet over the real, however, is likely to be in coffee. Traditionally, Brazil has been such a dominant producer of the arabica beans from which high-quality brews are made that speculators would use them as a way of placing bets on the real, and vice versa. When the currency weakens, output goes up and arabica prices go down.

That appears to have broken down in recent years. At a time when the real is trading close to record lows, coffee is at its highest levels in a decade. Investors don’t expect this to be an anomaly, either: With reports of poor crop performance from the coffee belt, traders’ net long position in arabica futures is only just below record levels, suggesting they expect prices to rise further.

That’s a bold bet. Brazil’s fiscal turmoil and slumping currency is already roiling and upending markets in soybeans, beef and chicken. Don’t be surprised if it repeats the trick in coffee.

BLOOMBERG OPINION

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