Trading Day: Powell in no rush to cut

By Jamie McGeever

ORLANDO, Florida (Reuters) -TRADING DAY

Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist 

The dollar and U.S. bond yields rose while Wall Street mostly fell in an eventful session on Wednesday, as investors digested U.S. and euro zone GDP figures, new tariffs from the White House, and Fed Chair Jerome Powell's press conference after the central bank left interest rates on hold.

More on all that below. In my column today I look at why Brazil may be holding

the world's worst hand in the game of trade negotiation poker with the Trump administration. And it's due to politics, not economics.

If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.

1. Rebound in US economic growth in second quarter masksunderlying slowing trend 2. Euro zone growth holds up better than feared in Q2 3. Trump says US to hit India with 25% tariff startingAugust 1 4. Bank of Canada holds rates steady and says global tradewar risk has eased 5. IMF could do with a bigger crisis than it forecasts:Mike Dolan

Today's Key Market Moves

* FX: Dollar accelerates rally, rising 1% on an indexbasis to a two-month high. * STOCKS: Wall Street gives back earlier gains. S&P 500and Nasdaq end 0.1% either side of flat, Dow down 0.4%. * SHARES/SECTORS: Microsoft shares jump 6%, Meta sharesleap 10% in after-hours trade following Q2 results. * BONDS: U.S. Treasury yields rise across the curve, asmuch as 6 bps at the short end as September rate cut hopes fade. * COMMODITIES: Comex copper futures plunge nearly 20% onTrump's new tariffs. Platinum falls 6%, gold down 3%.

Powell in no rush to cut

Surprisingly strong U.S. growth figures and Federal Reserve Chair Jerome Powell's press conference were the chunkiest plenty else to feast on for investors on Wednesday, but they had plenty other morsels to chew on too. 

Investors had upbeat euro zone growth figures, a rate decision from Canada, and new U.S. tariffs on India, Brazil and copper imports on their plate, and if that wasn't enough, after-the-bell earnings from Meta and Microsoft for dessert. 

The overarching message that investors took from Powell's press conference after the Fed left its Fed Funds target range at 4.25-4.50% was this: The central bank is in no rush to cut rates, despite the rare dissent from two policymakers to do so.

Powell said the labor market is strong and effectively at full employment, so that side of the Fed's dual mandate is being met. But inflation is above target and the outlook remains cloudy due to the impact from tariffs, so the inflation side of the dual mandate is not being met. Taken together, policy is rightfully "modestly" restrictive. 

Markets reacted accordingly - rates traders slashed their expectations of a rate cut in September, and are now only fully pricing in a cut by December. The dollar and yields extended their gains, and Wall Street erased its gains.

The most dramatic market reaction was in FX. The Dollar Index leaped 1% to a two-month high and is on track for its best week in three years. On the flip side, the euro is down more than 2% since Monday and on track for its biggest fall in three years. 

On the economy, Powell said the first estimate of Q2 GDP was broadly as policymakers had anticipated. The U.S. economy expanded at a 3.0% annualized rate in the second quarter, faster than the consensus forecast of 2.4%. On the face of it, this looks nothing but bullish.

But that was skewed by a record rebound in net trade, which followed a record negative contribution from net exports in the first quarter. Private domestic final purchases, a gauge of underlying demand, rose at its slowest pace since 2022.

In effect, headline growth is masking weaker underlying data. Most economists agree that the highest tariff rates since the 1930s will likely hurt the U.S. economy to some degree at some point. But right now, the pain appears just about manageable.   

Trump spat leaves Brazil holding world's worst tariff hand

U.S. President Donald Trump has tempered his most belligerent trade threats and begun striking deals with major partners, meaning most countries won't face the punishing tariffs announced on 'Liberation Day'. Not so with Brazil. 

In fact, Brazil's trajectory has gone in the opposite direction. On April 2, Brazil faced the minimum 10% tariff rate, but if a deal is not reached by the end of this week, South America's largest economy is staring at a whopping 50% levy.

That's significantly higher than the 15% rates negotiated in both the U.S.-Japan and U.S.-European Union deals. Setting aside China, the 50% charge would match the highest levy applied to any country in the Liberation Day tariff program.

And, importantly, the impasse is rooted in politics, not economics. Brazil is one of the few major economies with which the United States runs a trade surplus. Indeed, it has done so every year since 2007, with last year's goods surplus clocking in at $6.8 billion on a total trade volume of $91.5 billion, U.S. Census Bureau figures show.

Trump has tied the 50% tariffs to judicial moves in Brazil against former right-wing president and ideological ally Jair Bolsonaro, who has been accused of plotting a coup following the storming of government buildings by his supporters after the election victory of leftist President Luiz Inacio Lula da Silva. "LEAVE BOLSONARO ALONE!" Trump wrote on social media earlier this month.

Diplomatic relations are frosty right now, and between Trump and Lula they are downright icy. The prospect of them thawing by the end of this week is negligible.

"Trade deals are a result of negotiations, but there is no dialogue if the U.S. doesn't respond to our letters. I'm worried," said one Brazilian government official.

THE TARIFF TOLL

Brazilian industry lobby, the CNI, estimates that the imposition of 50% U.S. import tariffs could result in the loss of over 100,000 jobs and knock off 0.2 percentage points from Brazil's annual economic growth. Brazil's agribusiness lobby, CNA, warns exports to the U.S. – the country's second-largest trading partner - could fall by half. 

And this is an especially delicate juncture for Brazil. 

Foreign exchange flows have turned negative in June and July, and this year's rally of Brazil's currency, the real, has stalled. On top of this, foreign direct investment has slowed in recent months.

That is a dangerous development because Brazil's current account deficit of 3.4% of GDP in the 12 months through June was more than double the deficit a year earlier. At current rates, FDI inflows will no longer cover that gap. 

REAL RATES 

Given this backdrop, Brazil's central bank now finds itself in a bind. 

Inflation has risen over the last year to eclipse 5%, putting it above the central bank's upper-band limit of 4.5% for six consecutive months. In response, the central bank has hiked the benchmark Selic interest rate to a two-decade high of 15%. 

The central bank is expected to leave the Selic at 15% on Wednesday, and is unlikely to have the wiggle room to cut for several months. High interest rates are needed to get inflation back in its box, attract deficit-plugging inflows from abroad, and support the real.

But the domestic economic price is high. Inflation-adjusted interest rates in Brazil are now around 10%, the highest in the G20 – topping even those of Russia and Turkey – and among the most restrictive real policy rates in the world. 

High borrowing costs are, unsurprisingly, slowing credit growth in Brazil, and in June a broad measure of default rates on consumer and business loans rose to its highest level since February 2018.

What's more, sizeable interest payments are the primary factor behind the ballooning public debt, because nearly half the country's debt is linked to the Selic rate. Federal public debt expanded by 567 billion reais ($101.53 billion) in the first half of this year, of which 393 billion reais was interest payments.

Brazil's primary budget, excluding interest payments, is close to balance. But the government's interest bill is fast approaching 1 trillion reais a year, some 7% to 8% of GDP. This is set to help drive the country's gross debt-to-GDP ratio above 82% next year from 76% currently. 

For policymakers in Brasilia, detente with Washington can't come quickly enough.  

 What could move markets tomorrow?

* Australia retail sales (June) * China official manufacturing PMI (July) * Bank of Japan interest rate decision * Japan retail sales (June) * Japan industrial production (June) * Taiwan GDP (Q2, prelim) * Hong Kong GDP (Q2, advance) * Samsung results (Q2) * Japanese earnings including Mizuho, Sumitomo * Germany CPI inflation (July, prelim) * U.S. PCE inflation (June) * U.S. Chicago PMI (July) * U.S. weekly jobless claims * U.S. earnings including Amazon, Apple, Mastercard

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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.

(By Jamie McGeever;)