The market increasingly expects a 50-basis-point hike in the Selic policy rate by November, with forecasts of 12% per year rate or higher gaining traction

09/25/2024

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After the Central Bank’s Monetary Policy Committee (COPOM) maintained a notably harsh tone in the minutes of its last meeting, the market has increasingly consolidated the view that accelerating monetary tightening will be necessary starting in November. The likelihood of a 50-basis-point increase in the Selic policy rate at the next decision gained further support, with market participants viewing this scenario as increasingly probable. Meanwhile, the monetary authority emphasized its vigilance regarding the inflationary challenges posed by an economy operating above capacity and current inflation remaining above target.

In the digital options market, the probability of a 25-basis-point hike at the next meeting slipped slightly from 18% to 17%, while the likelihood of a more aggressive 50-basis-point increase rose from 64% to 66%.

J.P. Morgan was among the banks revising its projections, now anticipating a faster tightening ahead. The bank shifted its forecast from three more 25-basis-point increases in the Selic rate to a more accelerated pace in November and December, expecting the tightening cycle to culminate with the basic interest rate at 12% in January. In a report to clients, economists Cassiana Fernandez, Vinicius Moreira, and Mirella Sampaio highlighted concerns over fiscal risks and the relatively muted easing of the exchange rate.

According to the J.P. Morgan economists, recent developments in the fiscal sphere, particularly after the release of the bimonthly revenue and expenditure report, “cast doubt on the credibility of the fiscal framework and its key parameters, namely the spending cap and the primary result target.”

In the minutes, the COPOM dedicated more attention than usual to evaluating the fiscal situation. When outlining factors driving demand, the board pointed to expansionary fiscal policy. Another section emphasized the importance of a credible fiscal policy “based on predictable rules and transparency in its results,” as well as strategies that reinforce the commitment to the fiscal framework, which are crucial for anchoring inflation expectations and reducing risk premiums on assets.

The COPOM also indicated that its baseline scenario includes a gradual slowdown in public spending growth over time. The minutes further emphasized that “synchronous and countercyclical monetary and fiscal policies contribute to ensuring price stability.”

“It’s a tone of concern, and we know this has grown over time, especially with the output gap [a measure of economic slack] being positive. The minutes clarified the COPOM’s positions better,” said Solange Srour, director of macroeconomics for Brazil at UBS Global Wealth Management, highlighting the signals related to the fiscal framework. “It’s clear this will lead to a more restrictive monetary policy,” she adds, noting that the market is already pricing in an accelerated pace of tightening, even entertaining the possibility of a 75-basis-point hike in the Selic rate.

“What remains for the market, then, is the question: if the Central Bank is so ‘hawkish’ on activity, inflation, and the fiscal situation, why only deliver a 25-basis-point hike?” Ms. Srour asks. She suggests that the COPOM’s caution regarding a more gradual start to the tightening cycle “doesn’t seem to stem from domestic conditions” but is likely influenced by external factors, “which is somewhat inconsistent with the statement that there is no mechanical relationship between Fed policy and Brazil’s or between the exchange rate and interest rates.”

An acceleration of the pace is, therefore, necessary. “A 25-basis-point hike is minimal. I think it’s natural for the market to expect three 50-basis-point increases. Whether that will be sufficient depends heavily on external factors. Domestically, I don’t see anything significant that would make the cycle less aggressive,” argues Ms. Srour.

In the view of Porto Asset Management’s chief economist, Felipe Sichel, the minutes indicate that the COPOM’s gradualism was limited to the beginning of the cycle. He believes the restrained start of the Selic rate hike aligns with the Central Bank’s scenario, which includes robust economic activity, upward inflationary pressure, and the possibility that the neutral interest rate—the rate that neither stimulates nor contracts economic activity—may have risen.

“We started the cycle with gradualism. Our base case currently projects 25-basis-point increases, but it’s clear the COPOM is data-dependent,” Mr. Sichel notes. He adds that the firm’s projection for the Selic rate is under review and that they are waiting for the release of the Inflation Report on Thursday (25) for further clarity.

At Quantitas, chief economist Ivo Chermont now expects three 50-basis-point increases in the basic interest rate, followed by a final 25-basis-point hike in March, bringing the Selic to 12.5%. Previously, the firm had projected the rate to reach 12%.

“Inflation expectations remain a concern because, even after a more ‘hawkish’ COPOM and its strong message of commitment to the target, the Focus report hasn’t improved,“ says Mr. Chermont, referring to the further deterioration in inflation projections released on Monday (23). “Part of the explanation likely stems from the fiscal situation, which has worsened in recent weeks,” he argues.

The Quantitas economist also highlights that their scenario revision wasn’t based on new data but on the Central Bank’s acknowledgment of a positive output gap and the inflation projection increase for the relevant horizon, from 3.2% to 3.5%.

Canvas Capital’s chief economist, Camila de Faria Lima, expects the Selic rate to reach 12% per year by the end of the cycle in January 2025. According to her, the COPOM will need to accelerate the pace of tightening at its November meeting unless economic activity and inflation cool down quickly.

“Unless we see a significant shift in activity or more positive surprises in the inflation breakdown, I believe the most likely outcome is a move to 50 basis points,” says Ms. Faria Lima. She adds that the minutes reiterated the Central Bank’s “deep concern” in reinforcing its commitment to hitting the inflation target within the relevant monetary policy horizon.

The demand for increased spending and attempts to exclude certain expenses from the fiscal target—such as expanding the gas allowance and combating fires—creates a “sense of lost transparency that is very damaging,” argues the Canvas economist. “The market doesn’t believe the government will pursue a better primary result to stabilize the public debt trajectory,” she said. “It would be beneficial to have clarity and a correction to this narrative.”

Still, she doesn’t foresee the Central Bank accelerating the pace of tightening beyond the 50-basis-point hikes she has projected, which the market has already priced in.

*Por Gabriel Caldeira, Victor Rezende, Gabriel Shinohara, Alex Ribeiro — São Paulo and Brasília

Souce: Valor International

https://valorinternational.globo.com/