Negative GDP in Q3 Catches Market's Attention

The Brazilian economy started 2025 with artificial momentum. Fiscal stimuli, an expansion of the income tax exemption threshold, and a reduction in the INSS queue created a sense of heating in the first quarter. Now, with these effects dissipating and the Selic rate at a contractionary level for an extended period, the scenario has changed. The question that economists from banks and consultancies are beginning to answer is straightforward: could GDP turn negative between July and September?

The available data so far indicates that yes, this possibility is real. It is not a technical recession or systemic crisis, but a slowdown that has spread across practically all sectors of the economy simultaneously. What matters for investors and market watchers is to understand the dynamics behind this cooling and what it signals for the coming months.

What the Activity Indicators Show

The IBC-Br, considered the monthly thermometer of GDP by the Central Bank, fell by 0.64% in June, a decline greater than the market expected. More relevant than the isolated number is the composition: excluding the agricultural sector, industry, services, and taxes all declined together. When all components move in the same negative direction, the signal of deceleration gains consistency.

The first preliminary data for July did not bring relief. The retail sales indicator calculated by Santander in partnership with Getnet (Iget) showed a 0.1% drop compared to June. Itaú's proprietary activity indicator (Idat) fell by 0.5% on the same basis. The flow of vehicles on toll roads remained stable, according to ABCR, while the consumer and business confidence indices from FGV declined and remain below 100 points, the line that separates pessimism from optimism.

When looking at the whole, the conclusion is the same as that summarized by economists at Bank of America in a recent report: "the long-awaited deceleration is finally consolidating." Of the ten high-frequency indicators monitored by the bank for July, three were in negative territory and four hardly moved at all. In June, six of them declined. The trajectory of the Brazilian economy in recent months shows a loss of traction that goes beyond a mere adjustment.

High Interest Rates Finally Take Their Toll

The resilience of the economy in the face of high Selic rates surprised analysts for several quarters. Now, this resilience is fading. The diagnosis from Sergio Vale, chief economist at MB Associados, is that the loss of dynamism was already contracted. The unknown was the timing: when the monetary tightening would be transmitted to activity with enough intensity to curb growth.

According to Vale, the second quarter should already show evident deceleration on the margin, heading towards a possible GDP decline in the third quarter. His assessment is that the economy has lost traction and it will be difficult to imagine a reversal in the final quarters of the year. Marianna Costa, chief economist at Mirae Asset, shares this view. For her, if the deceleration in the second quarter is slightly greater than expected, the probability of negative GDP between July and September increases.

Bank of America’s estimates indicate that GDP growth fell from 1.1% in the first quarter to 0.3% in the second. The relevant change, according to the bank's economists, "is not the weakness in a single indicator, but the increasing consistency among them." When restrictive monetary policy works, it works through all channels simultaneously: more expensive credit, increasing indebtedness of families and companies, and retracted consumption.

Fiscal Impulse Lower Than Expected

Part of the negative surprise in the second quarter can be explained by government stimuli that did not deliver the expected impact. Itaú revised its estimate of the fiscal boost to activity in 2025 from 1 percentage point to 0.8 percentage points. The expansion of the income tax exemption threshold shows limited signs of transmission to consumption. The reduction of the INSS queue did not translate into an increase in benefits to the projected magnitude.

This is a crucial point for understanding the trajectory of the economy. The strong first quarter did not reflect solid fundamentals, but rather a temporary push from government measures. With this boost fading as high interest rates intensify their effects, the result is an economy that is slowing down faster than consensus projected.

The Focus bulletin, which aggregates market projections, indicates growth of 1.98% for GDP in 2025 and 1.5% in 2026. However, the bias, according to Costa, is downward revision. Current projections still carry the legacy of the strong first quarter, which masks the trend of weakening in the following quarters.

What this means for investors

A slowing economy changes the equation for various asset classes. On the positive side, the confirmation that high interest rates are fulfilling their role of cooling demand may open the door for the Central Bank to start cutting the Selic rate earlier than the market currently prices in. If activity data continues to be weak and inflation converges, the pressure for monetary relief gains strength.

On the negative side, cyclical sectors tend to suffer. Consumer, retail, and construction companies feel the effects of a weaker GDP first. The FGV-Ibre GDP Monitor has already shown an expansion of only 0.3% in the second quarter, practically stagnation.

The scenario is not one of crisis, but of adjustment. The Brazilian economy is transitioning from a period of artificial resilience, sustained by targeted stimuli, to the reality of interest rates weighing on credit, investment, and consumption. For investors, the message is clear: profit projections for listed companies in the second half may disappoint. And, paradoxically, this economic weakness may be the catalyst that the fixed income market and long-duration assets need to start performing again.