Lack of consistency in inflation projections still worries asset managers
The Central Bank has tried to cool expectations that it will start reducing Brazil’s key interest rate as early as the first quarter of 2023. The fact that short-term inflation slowed down and commodity prices went south in the international market was a determinant to bringing down future interest rates in the last few days. This backdrop paved the way for the market to price in the yield curve the key rate, known as Selic, below 13.75% per year as early as March 2023.
The rise in future rates on Tuesday partly eliminated this variation. Yet, some market participants still expect interest rate cuts early next year.
Central Bank President Roberto Campos Neto told the audience at an event held by Valor on Monday that the monetary authority is not thinking about lowering interest rates at this moment. He has also reinforced the message of the last meeting of the Monetary Policy Committee (Copom), in August, when the Central Bank indicated that it will analyze the need for raising the Selic once more. Mr. Campos Neto’s message was reinforced by Bruno Serra Fernandes, the bank’s monetary policy director, who showed concern on Tuesday about the de-anchoring of inflation expectations for 2024 – the median is 3.43%.
“The work of the Central Bank has already been done. It recognizes this and has signaled that, from now on, it must remain cautious in order to bring inflation expectations to the target. We agree. The Central Bank must remain cautious, but we also think that this stance will make inflation converge to the target,” said Gustavo Pessoa, a partner and fixed-income manager at Legacy Capital. The firm’s baseline scenario includes rate cuts starting in March 2023.
“Since inflation is just starting to slow down, the Central Bank doesn’t want to commit to cuts, but reality will weigh in. Inflation has started to give way strongly, and not only because of the government’s measures. And this lower inflation has left the real interest rate [ex-ante] close to 9%, a level that will be enough to make inflation converge to the target. This will allow the Central Bank to start cutting interest rates at some point,” Mr. Pessoa said.
In Legacy’s view, in March 2023 the monetary authority will look, in particular, at inflation for 2024 on the relevant horizon, whose expectation is today at 3.43%. “We expect expectations to anchor again and the median of 2024 projections to return to 3% by March. The Focus expectations will probably drop, given the Selic rate level. So it would be a natural path for the Central Bank to start cutting interest rates. We think this will happen as of March, and how fast interest rates will drop depends a lot on inflation dynamics here and abroad,” he said.
On Monday, the yield curve was pricing a cut of about 0.20 percentage points in March 2023 as the starting point for an easing cycle. After the market closed on Tuesday, there was a relevant repricing, and the market stopped betting on cuts in the first quarter of next year.
Alexandre de Ázara, the chief economist of UBS BB, believes that Mr. Campos Neto wants to combat expectations of a premature start to the easing cycle. “I believe he said that it is important to maintain interest rates flat for a while. In my view, the Central Bank doesn’t like to see the market price cuts in the first quarter and I think he wanted to fix that,” he said.
Mr. Ázara believes it is early to price a cut in the first quarter, but sees room for stronger cuts throughout next year, as of June. UBS BB projects that in 2023 the Central Bank will make four 100-basis-point cut in the Selic rate, starting in the second meeting of the second quarter, and a final 50-basis-point reduction in 2023. In addition, the bank expects the cycle to continue in 2024, with the Selic reaching 7.75%.
“This will help inflation to converge to the target in 2024. If it falls too slowly, inflation will not converge in 2024. If it falls too early, it will not converge in 2023,” said Mr. Ázara, whose projection for Brazil’s official inflation index IPCA next year is 4%, well below the market consensus of 5.27%.
Cooler commodity prices in the international market have been key for the downward variation in short-term interest rates in recent weeks. Brent oil prices, now close to $90, drew attention.
Jose Carlos Carvalho — Foto: Leo Pinheiro/Valor
“For two and a half years, commodities put upward pressure on inflation. It was a headwind that is now changing a little into a tailwind. I think this factor hindered the Central Bank a lot, but now it can be helpful,” said José Carlos Carvalho, a partner and head of macroeconomics at Vinci Partners. Yet, he recalled that services inflation is still under pressure. “Activity is still strong and should remain that way, but commodity-related prices more than make up for the rise in services.”
Mr. Carvalho believes that the Central Bank closed the monetary tightening cycle with the Selic at 13.75% and has a downward trajectory of interest rates ahead, considering that the real interest rate in Brazil is between 7% and 8%. According to him, these are quite high levels, well above the natural rate of interest, which is around 4%. “With help from commodities and the time for monetary policy to make its effect, the cycle of Selic hikes is over. There is no reason for the Central Bank to deliver even higher interest rates,” he said.
The cycle of interest rate reduction is related to the new federal administration and its fiscal policy, the executive with Vinci said. “In the first quarter of 2023, the Central Bank will still want to understand the fiscal policy of the next administration. In the second quarter, if it is the right thing to do, it can start thinking about cutting interest rates,” Mr. Carvalho said.
The fiscal policy is precisely one point highlighted by Tomás Goulart, the chief economist of Novus Capital, to advocate the view that the key interest rate is unlikely to start being reduced at the beginning of next year. He also cited the level of interest rates in developed countries, especially in the United States.
“The fiscal anchor is the first condition for the Central Bank to start reducing the Selic. It must know what the fiscal anchor will look like in the next administration, given the fact that the spending cap has lost credibility,” he said, citing the rule created to limit growth in public spending to the previous year’s inflation, which was circumvented by the Bolsonaro administration. The monetary authority will only feel ready to start easing the Selic when it finds out which fiscal regime will prevail in Brazil, he said.
“And then, considering the legislative process, we still don’t know what the next administration will be and what will be proposed in terms of an anchor. There is no clarity at the moment. And the legislative process to replace the fiscal anchor and pass something in Congress that has credibility should take around six months, that is, it will be time-consuming,” he said. When assessing the necessary conditions for the Central Bank to start reducing the key interest rate, Mr. Goulart said that such a cycle may start in June or August 2023.
*By Victor Rezende, Gabriel Roca — São Paulo
Source: Valor International