Agents are divided over the Monetary Policy Committee’s next move; dollar forecasts jump from R$5 to R$5.10
04/22/2024
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Andrea Damico — Foto: Claudio Belli/Valor
Increased local and external uncertainties have triggered a wave of revisions to the Selic policy rate in recent weeks. Although the market is very divided over the size of the interest rate cut expected at the next meeting of the Central Bank’s Monetary Policy Committee (COPOM), the median forecast for the rate at the end of 2024 has seen a significant jump. At the same time, the outlook for the exchange rate also worsened, rising from R$5 to R$5.10 at the end of the year.
In a survey conducted by Valor with 93 financial institutions, 50 said they expected the COPOM to maintain the guidance given in its last decision and cut interest rates by 50 basis points in May. The other 43 are already betting on a reduction in the pace of easing to 25 bp. The rate currently stands at 10.75% per year.
Even more notable is the change in agents’ perception of the room the Central Bank has to continue reducing the Selic rate in 2024 and 2025. If, in the previous survey conducted by Valor in March, the median estimate for the interest rate at the end of the cycle was 9%, now the indication is 9.75%. The level is also higher than that observed in the Focus Bulletin, Central Bank’s weekly survey with economists, currently at 9.13%. The path for basic interest rates at the end of next year followed the same direction and rose from 8.5% to 9%.
The wave of revisions took place over just 10 days. The surprise rise in the U.S. consumer price index was coupled with new evidence that the U.S. economy remains strong, pushing bets on the start of U.S. interest rate cuts further and further forward. At the same time, escalating tensions in the Middle East supported oil prices. In the domestic environment, the revision of the fiscal target led to a worsening in the perception of risk regarding the sustainability of public accounts.
With the risk scenario deteriorating on multiple fronts, Central Bank President Roberto Campos Neto went public last week and outlined four possible scenarios for the next steps in Brazil’s monetary policy. In practice, according to agents, the president was trying to distance himself from the monetary policy stance indicated in the last decision’s announcement, which suggested that another 50 bp cut in the Selic rate was appropriate.
According to Cristiano Oliveira, chief economist at Banco Pine, Mr. Campos Neto’s speech will be beneficial for guiding agents in the short term. “If market uncertainties don’t diminish, everything indicates that there will be a reduction in the pace of interest rate cuts here in Brazil. I saw the speech as very important because, in an inflation-targeting regime, the monetary authority must always have very up-to-date forward guidance that takes into account the reality of the facts. The guidance in the announcement and the post-COPOM minutes referred to a world that no longer exists,” he said.
For him, another factor that signals that economists recognize that the space for interest rate cuts has shrunk is the recent upward movement in Focus’s inflation projections for 2025.
“I believe that some economists will continue to revise upwards their inflation projections for 2025. The output gap is closing faster than expected. There is a discussion about the disinflation process in Brazil, which is having less momentum now. That shows that there is less room for interest rate cuts than was assumed months ago. I also thought they could cut more, but reality has changed. In addition, the fiscal trajectory generates more concern,” he explained.
According to Mr. Oliveira, since the beginning of the rate-cutting cycle, the Central Bank had indicated that interest rates would remain in contractionary territory. “I believe it should now be even more contractionary. There was never a full convergence of expectations. What the Central Bank did was make an initial adjustment, cutting interest rates by 300 bp, and now it must start fine-tuning. I believe this adjustment will be another 100 bp, divided over four meetings,” he said.
For Andrea Damico, chief economist at Armor Capital, if the COPOM’s decision were made today, the most likely outcome would be a reduction in the pace of cuts. However, if the exchange rate returned to a level closer to R$5.10 per dollar, the scenario would allow the Central Bank to adhere to its guidance and reduce the Selic rate by 50 bp.
“We haven’t revised [the projection for the Selic rate] to a 25-bp cut because we understand that we’re at a time of significant market volatility. I can’t imagine that the exchange rate will stabilize in the R$5.30 range. We have factors that could allow it to return to R$5.10, and we need to wait for these events to unfold to be more convinced,” noted Ms. Damico.
In the economist’s view, there is little room for improvement in the external vector since the signals from the U.S. indicate that the economy remains resilient and the Federal Reserve (Fed), the country’s central bank, will make fewer interest rate cuts. However, local factors could contribute to a relaxation of assets and resume the possibility of a 50-bp cut in May.
“Here, there is some potential for reaction. We saw the news of Petrobras’ extraordinary dividends, which is a step in the right direction. There may be firmer speeches regarding fiscal credibility, and this would also be a good time for some announcements of spending review projects. We wouldn’t return to the scenario of a month ago, but some capacity for reaction exists, and we could see some improvement at the margin, as happened on Thursday and Friday.”
In the survey conducted by Valor, the median of the 90 companies that responded about the exchange rate indicated a projection of the dollar at R$5.10 at the end of 2024. BBVA’s Latin America strategist, Alejandro Cuadrado, says he has a position on the real against the dollar because he believes the Brazilian currency could appreciate. “At some point, things in the U.S. should cool down, and the indication of a cut in U.S. rates could help both the Brazilian interest rate market and the stock market,” he explained.
The strategist says he went long on the real when the exchange rate reached R$5.18, with a target of R$5.05. “Looking at the charts, you realize that there could be a good movement for the real ahead unless there are global risk adjustments. And since I don’t expect anything like that to materialize, I saw room to go long on the real.”
He says that the recent rise in market interest rates in Brazil played against the currency’s performance. “The real had a false appeal because [the rise in interest rates] was not favorable for those who were invested [betting on the fall] in interest rates and also played against those who were buying shares.”
For Mr. Cuadrado, the stock market is crucial for the performance of the real. “Since the crisis in 2015 and 2016, foreign investors have abandoned Brazilian fixed income and have not returned to the levels they once were. In contrast, the stock market has seen considerable development,” he noted.
This more optimistic perspective on the real, however, holds only in a context where the geopolitical crisis does not escalate, and the Central Bank does not adopt a more cautious stance on fiscal matters. “If things settle down by the COPOM meeting, I think the Central Bank will adhere to its previous commitment and cut rates by 50 bp. Then, at the following meeting, it should cut by 25 bp,” he said, estimating a Selic rate of 9.5% by the end of this year.
“The risk is if the Central Bank cuts the rate by 25 bp at the next meeting and reinforces its concerns about the fiscal situation, making harsh statements as it did at the beginning of the Lula administration. In that scenario, we could once again see tensions between the government and the Central Bank.”
According to Luca Mercadante, an economist at Rio Bravo Investimentos, the recent depreciation of the real is more closely tied to the higher risk premium embedded in the currency due to uncertainties about U.S. interest rate cuts, geopolitical tensions, or doubts about the sustainability of Brazil’s public debt. “Previously, the framework appeared more credible. When you compare the government’s targets and the expectations set by the Focus report, there was a discrepancy,” he explained. “The market did not fully embrace the trajectory that the government wanted to impose on public accounts, but this framework acted as a sort of anchor, which has now been compromised.”
Although the increase in the risk premium on the exchange rate is a recent development, Mr. Mercadante does not disregard the possibility that this movement could expand and overshadow the more positive current trade flow, especially with grain exports. “We don’t have a problem with the trade balance, but with a higher risk premium. The situations I mentioned are not static. There may be a worsening of the war, which affects oil production; the Fed might indicate that there will be no interest rate cuts this year; similarly, additional changes to the fiscal framework could worsen the outlook for debt evolution.”
*Por Gabriel Roca, Arthur Cagliari — São Paulo
Source: Valor International