While talks of further Selic rate hikes remain in focus, the stock market has surged 10.2% since early July
09/06/2024
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Aline Cardoso — Foto: Carol Carquejeiro/Valor
As the U.S. monetary easing cycle approaches, market participants are increasingly anticipating this month’s interest rate decision, expecting it could fuel further gains for the benchmark stock index Ibovespa. According to Santander’s analysis, U.S. Federal Reserve rate cuts tend to benefit the Brazilian stock market, provided they occur within the context of a soft landing for the U.S. economy. It’s no coincidence that, despite recent speculation about additional Selic rate hikes—Brazil’s policy interest rate—the Ibovespa has already surged by 10.2% in the second half of the year.
“This is an unprecedented cycle,” said Aline Cardoso, Santander’s head of research and equity strategy, emphasizing that if U.S. and Brazilian monetary policies diverge as expected, it would mark the first time since the Real Plan that Brazilian interest rates increase without the U.S. economy being in a deep recession.
Santander’s study recalls that in 1995, following a U.S. interest rate cut, the Brazilian stock market rose 20.1% in the quarter leading up to the decision, 15.8% in the three months after, and 22.6% over the subsequent six months. Similarly, in 2019, the Ibovespa gained 5.6% in the three months before the U.S. Federal Reserve initiated rate cuts, 5.6% in the following quarter, and 13.5% over the next six months.
“If U.S. interest rate cuts are implemented in a more stable economic environment, aimed at gently stimulating growth, they typically have a positive impact on both stocks and bonds,” notes Santander in a report authored by Ms. Cardoso and analysts Guilherme Bellizzi Motta and Luane Fontes, “as they signal confidence in the economy while offering support to financial markets.”
In contrast, during a U.S. recession, Ms. Cardoso points out that it has been rare for the U.S. Federal Reserve to cut interest rates while the Brazilian Central Bank was compelled to raise the Selic rate. “This has only occurred twice, during two extreme crises — in 2001, after the burst of the dot-com bubble, and in 2007, to stabilize the banking system,” she notes.
On the latter occasion, the recession was so severe that it led to heightened risk aversion, strengthening the dollar and weakening emerging market currencies, including the real. Faced with this shock, the Central Bank had to raise interest rates to curb inflationary pressures.
This time, however, Ms. Cardoso believes that any potential Selic rate hike could be driven by the need to restore the Central Bank’s credibility with economic and market agents. “The rise in interest rates would reflect the risk premium associated with changes in the Central Bank’s leadership next year, with the president and three directors stepping down. The market is concerned about how the monetary authority will navigate this transition,” she explains, noting that such uncertainty contributes to higher risk premiums on assets.
The Brazilian stock market has historically suffered during periods when U.S. monetary easing coincided with a “hard landing.” According to Santander, three months after a U.S. rate cut in such conditions, the Ibovespa declined by 5.5%, with a 5.8% drop six months later.
“Our analysis concludes that stock performance has been asymmetrical over time,” says Ms. Cardoso. “During mild economic downturns, both the Ibovespa and the S&P 500 tend to exhibit significant gains, with the upside often outweighing losses during more severe slowdowns,” she explains.
During periods of “extraordinary” interest rate cuts—often implemented in response to sudden shocks, such as in 1987 and 1998—the trend generally favors equities, provided the underlying credit or liquidity event does not severely impact the broader economy.
However, some market participants remain cautious about the potential impact of an additional tightening of the Selic rate on the stock market. In a note to clients, J.P. Morgan’s Latin America equities strategy team, led by Emy Shayo Cherman, highlights that equities have delivered negative returns during all rate hike cycles since 2008.
“What could be different this time? First, this tightening cycle is much shorter compared to previous ones. Second, there’s an expectation that all rate hikes will eventually be reversed, and even future easing could follow. Some may view this as a reasonable cost to bring interest rates down to single digits while simultaneously bolstering the Central Bank’s credibility,” the J.P. Morgan strategists explain.
Bank of America (BofA) professionals share a similar view, noting that if the Fed cuts interest rates amid a “soft landing,” the outlook could be positive for Latin American stocks, though local factors will also play a key role. “In Brazil, markets have already priced in Selic rate increases, and we continue to monitor concerns surrounding fiscal policy,” BofA’s strategists note.
BofA maintains its “overweight” recommendation (exposure above the market average) for Brazilian equities, emphasizing the country’s potential for corporate profit growth this year. Despite the Ibovespa’s recent rally, valuations remain “relatively attractive.”
*Por Maria Fernanda Salinet — São Paulo
Source: Valor International