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Analysis: Market still bets on interest rate cuts in 2023

Analysts’ median projection for Selic at end of 2023 was stable this week at 10.5%

07/12/2022

Central Bank's building in Brasília — Foto: Divulgação/Rodrigo Oliveira/Caixa Econômica Federal

Central Bank’s building in Brasília — Foto: Divulgação/Rodrigo Oliveira/Caixa Econômica Federal

Economic analysts have once again increased their inflation projections for 2024 and continue to bet on cuts in the basic interest rate in 2023, shows the Focus survey, released on Monday morning.

Overall, this movement in expectations reveals that the financial market is questioning the strategy of the Central Bank’s Monetary Policy Committee (Copom) of raising interest rates less now, but avoiding cuts next year.

At its last meeting in June, the committee said that if it raises the key interest rate less in the next few meetings, combined with keeping interest rates higher in 2023, it could bring inflation down “around the target” as early as 2023.

On that occasion, the Copom disclosed an alternative projection for inflation that shows that if interest rates were maintained at 13.25% per year during 2023, projected inflation for 2023 itself would drop to 3.7% from 4%. At this percentage, it would still be above the target, set at 3.25%, but the committee considers that it would be close enough to the target, given the great uncertainties affecting the economic scenario.

The Focus survey shows that, at least for now, the market has not bought the thesis of higher interest rates in 2023. The median projection of analysts for the Selic policy interest rate at the end of 2023 was stable this week, at 10.5% per year.

The market has doubts if, in fact, the Copom will keep interest rates stable in 2023 because, if it does, the inflation projected by the Central Bank itself for 2024 would be too low. In mid-June the Central Bank projected inflation at 2.7% for 2024, already below the center of the year’s target of 3%.

Some experts noted, when the Central Bank unveiled its strategy of higher interest rates for longer, that it is inconsistent with the usual way the Copom acts. The natural thing to do would be for the Central Bank to take care of inflation for the following year, cutting interest rates so that they do not get too low.

Moreover, the Central Bank’s own policy director, Diogo Guillen, said in the Inflation Report interview that signaling higher interest rates for longer in 2023 was not forward guidance. Forward guidance could tie the hands of the Central Bank and force it to keep interest rates higher even if circumstances over time suggest it should do otherwise.

Another set of data from the Focus survey that puts the Central Bank’s strategy in doubt is the evolution of market inflation expectations.

In the case of the figures projected for 2023, they rose to 5.09% from 5.01% last week. The figures expected for 2024 rose to 3.3%, against a target of 3%, after remaining stable at 3.25% for several weeks.

In part, this is a sign of market disbelief that the Central Bank will be able to meet targets with the current monetary policy strategy. It also reflects the fiscal risks, with tax cuts and increased transfers, that are likely to make disinflationary work difficult for a long period of time.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Analysis: Central Bank mulls keeping high interest rates for longer

Policymakers seem to hope that situation will improve to the point of making additional hike unnecessary

06/21/2022

Central Bank’s building in Brasília — Foto: Jorge William/Agência O Globo

Central Bank’s building in Brasília — Foto: Jorge William/Agência O Globo

Central Bank’s Monetary Policy Committee (Copom) is now considering the possibility of maintaining interest rates at a high level for longer to meet the inflation target. This would complement or replace the previous strategy of raising the Selic, Brazil’s benchmark interest rate, to even higher levels in the final leg of the monetary tightening cycle.

In the minutes of last week’s meeting unveiled Tuesday, the policymakers say they analyzed this possibility. They have also discussed which message to send about monetary policy for the next meeting, to be held in August.

As the inflation environment has deteriorated, the Copom decided that it was about time to raise the interest rate even more last week, to 13.25% a year from 12.75% a year. The policymakers have also signaled that they will keep interest rates at a high level for longer than the markets have been expecting in order to complement the necessary tightening dose. “The strategy of convergence around the target requires a more contractionary interest rate than that used in the reference scenario for the entire relevant horizon,” the minutes say.

In last week’s meeting, the reference scenario provided for an interest rate of 13.25% at the end of 2022, 10% at the end of 2023 and 8.5% at the end of 2024. This way, considering what the minutes say, the Copom seemingly believes that the interest rates must be above each of these percentages at the end of each year.

The minutes could not make it clear how a higher interest rate at the end of 2023 or 2024 will help to meet the inflation target on the relevant horizon, which is 18 months ahead. The interest rates in 2023 will impact inflation more in 2024 than in the current monetary policy horizon.

The alternatives between raising the interest rate to a higher level now or keeping the rate higher for longer were also analyzed when the Copom discussed future monetary policy signals for the next meeting, in August.

Here again, the Copom concluded that keeping interest rates high for longer will not be enough to meet the inflation target. As a result, the chosen strategy was to signal a 50-basis-points hike or a 25-basis-points hike, depending on the inflation rates until there.

In a very important point to consider regarding future signals of monetary policy, the Copom said the perspective of maintaining the Selic rate for a sufficiently long period would not assure, “at this moment,” the convergence of inflation around the target in the relevant horizon.

It has been a while since the Copom used this phrase when talking about future steps – the intention, historically, has been to highlight that any signal is reliant on the evolution of the economic scenario. If the committee considered it better to include the expression “at this moment” now, it probably sees chances of positive evolution of this scenario by August, in a way that allows meeting the target by only keeping the interest rates at the current level, of 13.25% a year.

On the other hand, the Central Bank made a point of reinforcing, as it had already done in May, that the outlook is very uncertain, so it requires caution. When they presented their inflation projections, the policymakers said that uncertainty “has increased since the previous meeting.” Caution, in this case, is related to the risk of setting a higher-than-necessary dose of interest rate.

The debate about the Copom’s decision started with the directors saying they have already done a lot. “It was emphasized that the current monetary tightening cycle was quite intense and timely and that, due to monetary policy lags, much of the expected contractionary effect and its impact on current inflation are still to be seen.”

All things considered, the Copom is moving to stop raising interest rates and to keep them high for a sufficiently long period. It signaled a new hike for August, but it seems to hope that the situation will improve to the point of making an additional hike unnecessary.

Will the Central Bank be able to stop raising the interest rates? The Copom has been signaling the end of the cycle since March, but it was not possible. This time, the policymakers decided to keep raising the rates because the “Copom observed deterioration in both the short-term inflationary dynamics and the longer-term projections.” The reaction function still seems to be in place: if more negative surprises come, the Central Bank will keep raising the interest rates.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Analysis: Copom’s scenario for oil called into question

Future curve suggests barrel north of $110 by the end of the year, 10% above Central Bank’s main scenario

06/14/2022

The main scenario for oil prices used by the Central Bank’s Monetary Policy Committee (Copom) to fine-tune its interest rate policy is being called into question amid new pressures on the commodity.

The Central Bank adopted a scenario A for oil at its March meeting to avoid dealing with the volatility of prices, which at the time were over $120 a barrel.

Instead, the committee assumed that “oil prices follow approximately the futures market curve until the end of 2022, ending the year at $100/barrel, and then start increasing 2% per year in January 2023,” according to the English version of the minutes of the 245th meeting of the Copom.

Lately, however, the future curve suggests a barrel north of $110 by the end of the year, which means a 10% higher price. The Brent oil price was around $120 a barrel earlier on Monday.

Etore Sanchez, the chief economist of Ativa Investimentos, says that a portion of the fuel price used in the Central Bank’s models is formed from the opinions of industry experts. “Because it is discretionary, it can end up mitigating the worsening,” he said.

Mr. Sanchez estimates that the price of gasoline in the domestic market is about 35% below international prices. Many other market economists are finding similar spreads in their calculations, around 30%, and some believe that Petrobras will soon be forced to raise its prices.

This spread tends to mitigate at least part of the price drop expected if the government achieves all its objectives with a package aimed at cutting federal and state taxes, partly temporarily.

The fuel price hikes surprised Central Bank’s directors, who in recent statements have highlighted the fact that the Brent oil price is no longer such a reliable indicator of the evolution of prices of oil products.

Central Bank President Roberto Campos Neto — Foto: Billy Boss/Câmara dos Deputados

Central Bank President Roberto Campos Neto — Foto: Billy Boss/Câmara dos Deputados

As many had predicted, the adoption of scenario A by the Central Bank has made it difficult to keep inflation expectations in check. Many analysts have maintained the previous practice of projecting inflation based on the current price of the product.

This is one factor among many others that explain the detachment of the Central Bank’s inflation projections for 2023, which at the Copom’s meeting in May was 3.4%, from market projections.

Market expectations for inflation in 2023 are already at 4.6%, according to an analysis published Monday by Valor, compared with the Central Bank’s target of 3.25% for the year.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Analysis: Market sees 12.75% as floor for interest rate

Many economists are questioning technical basis and rhetoric behind Central Bank's decision — Foto: Raphael Ribeiro/BC
Many economists are questioning technical basis and rhetoric behind Central Bank’s decision — Foto: Raphael Ribeiro/BC

Economic analysts, in general, understood that the Central Bank’s Monetary Policy Committee (Copom) signaled a rate of 12.75% per year at the end of the current interest rate tightening cycle. Yet many still see this level as the floor for the Selic, Brazil’s benchmark interest rate.

Economists and traders told Valor that the end-of-cycle signal, this time, was weaker and subject to revisions since the committee linked the future path of interest rates to the evolution of oil prices.

Others say that, even considering that the Central Bank’s intention is to stop at 12.75% per year, the inflationary scenario will remain challenging and, as a result, force the Copom to do more.

Others say that the cycle is unlikely to end up at 12.75% because, in that case, the committee will make one last sharp move in interest rates, 100 basis points. The Central Bank typically ends tightening cycles more smoothly.

There are still concerns, in part of the market, of an exaggeration in monetary policy. But even those who believe that the Central Bank has gone too far on interest rates consider it unlikely that it will deliver a rate lower than 12.75% per year. Wednesday, interest rates rose to 11.75% per year, and the Copom explicitly signaled a new 100 bp increase, which would take the Selic to 12.75%.

BGC Liquidez presents a look at the market mood shortly after the Copom’s decision in a survey of 162 economists and traders, distributed to its clients on Thursday.

Only 16% of respondents think that the Central Bank will stop at 12.75%. The most common bet, of 42% of those who took part in the survey, is that the interest rate will rise to 13.25%. On the eve of the Copom meeting, in another survey by the BGC, with 207 participants, only 26% mentioned this percentage. End-of-cycle bets of 13%, meanwhile, shrank to 6% from 27%.

This is, however, a snapshot of the moment, and many economic analysts want to wait longer for an eventual change in their bets for the Selic rate at the end of the cycle. They say the language of the Central Bank usually changes a lot between the release of the Copom statement and the minutes. Next week, the monetary authority will also release the Inflation Report, with a press conference.

Many economists are questioning, after the Copom meeting, the technical basis and rhetoric behind the decision, so they are waiting for the Central Bank to better explain what was discussed in it.

A question mark is the fact that the committee presented projections for the price index in an alternative scenario, incorporating a good part of the oil price drop that occurred until Wednesday, to show that inflation reaches the target in 2023 without a dose of interest rate higher than 12.75% per year.

Some in the market are skeptical about that, so much so that the projections for the Selic rate have risen. There was already a questioning of the monetary authority’s calculations due to the fact that the Copom’s inflation projections are below market estimates, of 3.7%.

Another point that bothers many economists is the change in the way the Copom analyzes the balance of risks. The committee basically said that the chances of inflation exceeding expectations were lower because much of the fiscal fears had already materialized in market expectations and in the foreign exchange rate.

For some, the Copom swept some fiscal uncertainty under the carpet to avoid having an inflation forecast adjusted by the balance of risks that requires an interest rate higher than 12.75% per year.

But this may just be a concern of economists, who have a more technical view of the Copom’s decision-making process. But market operators consulted by Valor on Thursday were more comfortable with the communication, despite the large number of people who think that the interest rate will have to go over 12.75% per year.

The survey by BGC Liquidez shows a divergence in the reading of the Copom statement between economists and traders. Among economists, 69% thought the message was “dovish,” or less inclined to tightening. Among traders, this percentage is 35%.

Source: Valor International

https://valorinternational.globo.com

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Central Bank raises interest rate, signals new hike

For the next meeting, the Copom foresees another adjustment of the same magnitude — Foto: Jorge William/Agência O Globo
For the next meeting, the Copom foresees another adjustment of the same magnitude — Foto: Jorge William/Agência O Globo

The Central Bank’s Monetary Policy Committee (Copom) raised on Wednesday the Selic, Brazil’s benchmark interest rate, by 100 basis points, to 11.75% per year. This is the ninth consecutive increase. For the next meeting, the Copom foresees another adjustment of the same magnitude.

“The Copom emphasizes that its future policy steps could be adjusted to ensure the convergence of inflation towards its targets and will depend on the evolution of economic activity, on the balance of risks, and on inflation expectations and projections for the relevant horizon for monetary policy,” says the committee’s statement.

This Wednesday’s decision was in line with the median of market expectations and within what was signaled by the monetary authority at the previous meeting – at the February meeting, the Central Bank indicated it would reduce the pace of monetary tightening, but did not specify the magnitude of the next adjustments. At the time, the Selic was raised by 150 bp, to 10.75% per year

In a survey carried out by Valor with 93 financial and consultancy firms, 82 expected the Selic to be raised by 100 bp, to 11.75%. Nine projected a 125 bp increase, while two believed the committee would keep the pace of interest rate hikes at 150 bp.

The Copom meets again on May 3 and 4.

For the Copom, in the external scenario, the environment has deteriorated substantially. “The conflict between Russia and Ukraine has led to a strong tightening in financial conditions and higher uncertainty surrounding the global economic outlook”, it stated. “In particular, the supply shock resulting from the conflict has the potential of increasing inflationary pressures, which had already been rising both in emerging and advanced economies.”

The committee says that it considers it appropriate for interest rates to advance significantly towards an even more contractionary terrain and “considers that, given its inflation projections and the risk of a deanchoring of long-term expectations, it is appropriate to continue advancing in the process of monetary tightening significantly into an even more restrictive territory.”

The Copom stated that “consumer inflation continued to surprise negatively. These surprises occurred both in the more volatile components and on the items associated with core inflation.”

In the statement, the Central Bank stressed that various measures of underlying inflation are above the range compatible with meeting the inflation target.

Regarding Brazilian economic activity, the Copom highlighted that the release of the GDP figures for the fourth quarter of 2021 indicated a higher-than-expected pace of activity.

The committee states that “the current projections indicate that the interest rate cycle in its scenarios is sufficient for inflation convergence to levels around the target over the relevant horizon.”

The Copom published two inflation projection scenarios, both considering a rise in basic interest rates to 12.75% per year, with a fall to 8.75% per year next year.

“The committee’s actions aim at curbing the second-round effects of the current supply shock in several commodities, which appear in inflation in a lagged manner”, it stated. “The Copom judges that the moment requires serenity to assess the size and duration of the current shocks.”

“If those shocks prove to be more persistent or larger than anticipated, the Committee will be ready to adjust the size of the monetary tightening cycle. The committee emphasizes that it will persist in its strategy until the disinflation process and the expectation anchoring around its targets consolidate,” the statement continues.

“The Committee assesses that the uncertainties regarding the fiscal framework maintain elevated the risk of deanchoring inflation expectations, but considers that this risk is being partially incorporated in the inflation expectations and asset prices used in its models. The Committee maintains the assessment of an upward asymmetry in the balance of risks.

The committee still sees both upside and downside risks to inflation.

“On the one hand, a possible reversion, even if partial, of the increase in the price of international commodities measured in local currency would produce a lower-than-projected inflation in its scenarios,” says the document.

“On the other hand, fiscal policies that imply additional impulses to aggregate demand or deteriorate the future fiscal path may have a negative impact on prices of important financial assets as well as pressure the country’s risk premium.”

Source: Valor International

https://valorinternational.globo.com

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