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If the Central Bank is willing to put inflation again at the center of the target range in 2023, the Selic, Brazil’s benchmark interest rate, must be raised above the expected 13.25%, said Cassiana Fernandez, J.P. Morgan’s chief economist for Brazil. For her, in a moment of high uncertainty, it is important that the monetary authority leave the door open for the coming steps in its statements. While the executive emphasizes the risks of high inflation in the short term, she also sees a more balanced scenario in the medium and long term given the stronger real against the dollar.
“Our recent revision of inflation for 2023 considers the IPCA [Brazil’s official inflation index] at 4.2% and a foreign exchange rate of R$5.3 to the dollar. With the exchange rate at R$4.7 to the dollar, I admit the downside risk to this projection,” Ms. Fernandez told Valor. She points out that the real tends to lose ground later this year in reaction to the tightening of the U.S. Federal Reserve and uncertainties about the presidential elections in Brazil, in October.
In this sense, the J.P. Morgan executive states that the high real interests in Brazil, seen in the yield curve of inflation-indexed bonds (NTN-B), reflect the risk premium over the uncertainty of Brazil’s economic policy in the coming years. “There is a risk premium regarding the credibility, not only of the Central Bank, but of the government and whether it will do what it needs to do to stabilize the debt as a proportion of GDP,” Mr. Fernandez said. Read the main excerpts from the interview below:
Valor: How far will the Central Bank tighten interest rates?
Cassiana Fernandez: We project a 13.25% Selic rate at the end of the cycle, in June, and the question mark is whether this will be enough. If the Central Bank wants to bring inflation to the center of the target range in 2023, it will probably require an even longer cycle. Our own projection [for the IPCA] is at 4.2% for 2023. The last few months have shown that there have been a lot of unexpected shocks in the global economy. Other factors have shown that the models are not matching the current scenario well. For me, it is difficult to say that a Selic of 14% is an unthinkable development, but I don’t think it is the most likely one.
Valor: What do you think of the most recent statement from the Central Bank?
Ms. Fernandez: [Central banker] Roberto Campos acknowledged the surprise of March inflation, which was significant. It was the biggest deviation in relation to the market consensus for the historical series, and 0.6 percentage points above the projection of the Central Bank. I think that a part of the market made a mistake when it considered that, with the signal that the Central Bank would stop tightening in May, it would be doing this regardless of the data. Roberto Campos’s remarks show that they are analyzing how this changes their scenario, without giving a clear sign whether they are going to maintain this guidance of stopping in May, but saying that they are open to reviewing the scenario.
Valor: But you were already predicting that the Central Bank would not be able to stop at 12.75%…
Ms. Fernandez: When the Central Bank announced that the next move would be a 100-basis-point hike and signaled that it might stop in May, just from what it projected for the March IPCA in the Inflation Report, we already had the perception that it would not be able to do this. So we forecast that it was likely to deliver another 50-basis-point hike in June. Given the uncertainties and the hikes as a whole, all this at least allows for it to pause in June to analyze other factors. I think it is even important for the Central Bank’s own communication to leave the door open for changes in the scenario because there are big risks. It is very difficult to say with conviction what is going to happen within the next two months.
Valor: Does the medium-term inflation scenario still have many upside risks?
Ms. Fernandez: In the short term, higher inflation is likely because the exchange rate appreciation is recent and commodities are a risk. But in the medium to long term, the picture is more balanced. Our recent revision of inflation for 2023 considers the IPCA at 4.2% and a foreign exchange rate of R$5.3 to the dollar. With the exchange rate at R$4.7 to the dollar, I admit the downside risk to this projection. And there are also the effects of the cut in the IPI [Industrialized Products Tax], which we are still unclear as to how it will affect the consumer, and the tightening cycle tends to be more severe. Our calculations show that it takes at least six months from the beginning of the interest rate hike cycle to have a real effect on inflation. Looking ahead, prices are likely to reflect the tighter interest rate.
Valor: How does the bank see the exchange rate trajectory?
Ms. Fernandez: We started the year very constructive about the currency, evaluating that the conditions favor the real, mainly commodity prices. High interest rates also help. In the short term, Brazil is in a comfortable position and it is difficult to find other countries to invest in. But, later in the second half and towards the end of the year, the elections and the [decisions of the] U.S. Federal Reserve could curb this appreciation. Our team started to project two consecutive 50-basis-point hikes in the United States and now projects a restrictive rate for the end of the year.
Valor: Does the scenario of activity also impacts the real?
Ms. Fernandez: Activity is likely to slow down, and this also tends to deteriorate the exchange rate scenario. Demand is expected to suffer from monetary tightening, and we expect Brazil to enter a recession in the second half of the year, not to mention the uncertainties regarding the elections and the fiscal policy from 2023 on. Three factors are expected to hold back the appreciation of the exchange rate: the accommodation of commodity prices, the domestic dynamics and the higher interest rates in the U.S.
Valor: What does the Fed tightening means for the Brazilian central bank?
Ms. Fernandez: Fed tightening also helps the Central Bank because Brazil has been importing a lot of global inflation. Actually, if the global situation is softened, the Fed would help.
Valor: But doesn’t a hike in U.S. interest rates tend to strengthen the dollar?
Ms. Fernandez: Yes, the Fed tightening manifests itself through the exchange rate channel, but this impetus to control American inflation and slow down demand in the U.S. would also cause global inflation to fall. Just take a look at the recent behavior of commodities. The risk of China growing less because of lockdowns weakens commodities, which ends up bringing projections of lower global demand. Lower commodity prices would help global inflation to fall, but would not help the exchange rate since we are large exporters of commodities. Everything has a limit, of course.
Valor: What would this limit be?
Ms. Fernandez: If we see a strong increase in interest rates and in the yields of U.S. Treasuries, generating great aversion to risk, this would harm emerging markets and Brazil. But we do not see this scenario as the main one yet. We expect a relatively gradual increase in interest rates and in global financial conditions.
Valor: The real yield curve in Brazil implies rates around 5.5% and close to 6% in some parts. What does this mean?
Ms. Fernandez: It does draw attention. Because if you look at the real interest rate for the NTN-B 2055, for example, it is around 5.5%. It is a very difficult real interest rate to materialize, and, if it does, we will most likely have a much bigger public debt problem. If the neutral real interest rate is between 4% and 4.5%, there is a premium given the uncertainty about economic policy in Brazil over the next few years.
Valor: How do you see the sustainability of the debt in the long term?
Ms. Fernandez: There is a risk premium in the real yield curve in relation to the credibility, not only of the Central Bank, but of the government and whether it will do what it needs to do to stabilize the debt as a proportion of GDP. Today, any exercise of ours of the dynamics of the public debt with the current figures show that a convergence of the debt in the long term to lower levels is very difficult. Brazil has a very low potential growth for emerging markets standards, which we can say is around 1 to 1.5%, and a very high debt, above 80% of the GDP, a scenario compounded by the neutral real interest rate of around 4%.
Source: Valor International