After three and a half years, Brazil is expected to have again a double-digit basic interest rate (Selic), after the first meeting of the Central Bank´s Monetary Policy Committee (Copom) in 2022, this Wednesday. The prevailing expectation in the market is that benchmark interest rate Selic will rise to 10.75% per year and will not stop there.
The Central Bank has been raising interest rates since March in order to contain inflation, which last year reached 10.06%, the highest rate in six years and well above the target (3.75% or 5.25%, when considering the tolerance limit). The Selic rate, which also indicates the cost of financing the federal government in the market, is set by Copom to, in the short term, contain or stimulate demand and, thus, control inflation in accordance with the target established for each year.
At this moment, amid uncertainty about how far the interest rate hikes promoted by Copom will go, there is growing concern in the market about the behavior of long-term interest rates, which roughly reflect the confidence of economic agents and investors in the capacity of the National Treasury to pay the public debt. Long-term rates traded on the stock exchange on interest contracts maturing in three years or more are above 11% per year.
These rates punish the lives of families and companies much more lastingly, since they make long-term credit more expensive, as if there were a bet that, even after the monetary tightening in force, the interest rate will remain high for many years.
In practice, this movement has an even more harmful effect on the economy than the monetary tightening itself, which is already a source of concern for economists. The rise in the Selic has as a consequence a cooling of consumption, either because credit becomes more expensive, or because it creates a stimulus to savings. It also leads investors to migrate to fixed income, which explains part of the fall in share prices in the second half of last year.
Higher long-term rates amplify this contractionary effect and can make it more lasting and widespread. Future rates make financing lines for infrastructure projects more expensive, whose term is also longer, even generating supply risks ahead. This long interest rate, which indicates some kind of distortion and a lot of uncertainty about the future of the economy, can even alienate investors and make projects with extended horizons unfeasible.
At the same time, those fees can bring down the value of companies, as the valuation is calculated taking into account the long fees. “The discount rate was higher, which means that the value projected for companies becomes lower when it is brought to present value,” defines Igor Lima, partner and manager at Trafalgar.
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For Bradesco’s chief economist, Fernando Honorato, what explains this pressure on long-term interest rates is the fiscal risk, which has grown again in recent months. He recalls that a series of improvements in the fiscal framework, carried out from 2016 onwards, allowed the forward interest rate curve to undergo an adjustment and reflect more clearly the conditions of the economy. In addition to the spending cap, the change in the dynamics of the credit market, with the reduction in the supply of lines subsidized by public banks, and the creation of the Long-Term Rate (TLP) contributed to this adjustment.
For him, it is this risk that explains the real interest projected by long-term NTN-Bs, which today is around 5.6%, much higher than what was seen before the pandemic, of 3.5%. “I consider the increase in the premium of longer fees to the changes that have taken place in the spending cap,” he says.
The effects of the long-term interest rate and the tighter financial conditions create a “very negative” scenario for economic activity, warns the chief economist of ASA Investments, Gustavo Ribeiro, who projects a retraction of 0.5% in the GDP this year.
Another aspect to be noted is the cost of public debt, which is at the center of the debate and is a major source of uncertainty for investors. At this point, observes Sérgio Goldenstein, chief strategist at brokerage Renascença, the Selic has a more direct impact on the debt stock. Also, the 36.8% slice of post-fixed securities (R$2.1 trillion), the amount of R$1 trillion in repo operations is adjusted by the Selic. The effect of the long-term interest rate will be felt, therefore, in the rolling over of the public debt.
This year, the total domestic securities debt due is R$1.16 trillion and, if the current pattern is maintained, around 40% of this volume will be made through prefixed securities or NTN-B, but at higher rates than in the last three years. “The market has a limited capacity to absorb fixed-rate risk and the investor appetite has been limited by the dynamics of the curve,” says Mr. Goldenstein. “And for the curve to ‘close’, political and fiscal uncertainties have to diminish and the disinflation process needs to consolidate.”
Mr. Ribeiro, with ASA Investments, also notes that, in addition to domestic issues, the country must also deal with external factors, at a time when the future of monetary policy in the United States is being debated. The strong speech adopted by the Federal Reserve since the beginning of the year has promoted a rise in global interest rates, especially in developed markets, which supports the prospect of a higher neutral interest rate.
“We have had a major inflection in global assets, with the Fed pricing in interest rate hikes since the turn of the year. We have seen more hawkish signals from the Fed and is highly possible that an interest rate hike does not happen in March. In addition, the earnings reports reduction will also start earlier, generating a significant change in market pricing,” says Mr. Ribeiro. For him, the scenario became “less positive rather quickly” and affects not only Brazil but several countries.
The chief economist of Truxt Investimentos, Arthur Carvalho, also evaluates the repricing of the U.S. monetary policy as an additional factor of pressure on assets in emerging markets. For him, however, “given the size of the movement of the American real interest rate of ten years, which went from -1.1% to -0.6%, I think that the Brazilian long-term interest rate reacted lightly”.
Source: Valor International