External and local worsening increases bets that Central Bank will slow down the monetary easing cycle
05/06/2024
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Fernando Honorato — Foto: Ana Paula Paiva/Valor
The change in communication by the president of the Central Bank, Roberto Campos Neto, given the worsening external scenario and the perception of increased domestic fiscal risks in April has driven the financial market to bet that the Monetary Policy Committee (COPOM) will slow down the pace of interest rate cuts at Wednesday’s meeting. The scenario of slower monetary easing has already been adopted by two-thirds of market participants, according to a survey carried out by Valor.
Among the 118 financial institutions consulted by Valor, 78 expect a 25-basis-point cut in the Selic policy rate, while another 40 still see room for a 50-bp reduction.
The most recent number shows an increasing trend, in recent days, of projections that include a smaller interest rate cut. In Valor’s previous survey, carried out between April 18 and 19—after Mr. Campos Neto’s change in tone—54% of market participants saw a cut of 50 bp, while 46% projected a reduction of 25 bp.
April was marked by a significant worsening of the external environment. Inflation data above consensus estimates in the U.S. and resilient economic activity numbers pushed forward bets on interest cuts by the U.S. Federal Reserve. Moreover, the escalation of geopolitical tensions bolstered the dollar and oil prices, heightening agents’ pessimism regarding the disinflation process ahead.
Additionally, the Brazilian government’s announcement of a review of fiscal targets increased the perception of risk surrounding the debt trajectory, contributing to the foreign exchange rate reaching R$5.3 per dollar.
Amid the deterioration of the scenario expected by the COPOM, Mr. Campos Neto went public in mid-April and outlined the possibilities for the next policy meeting. In practice, the communication served to abandon the indication issued in the March decision that a further 50-bp cut was considered appropriate. This scenario would only return to the table if uncertainty was reduced.
In recent days, however, some relief abroad brought this possibility of a 50-bp cut back onto the radar and further intensified the market division concerning Wednesday’s decision.
“According to our model that replicates that of the Central Bank, any worsening in the exchange rate and inflation expectations tend to be offset by a higher Selic in Focus,” said Bradesco’s chief economist, Fernando Honorato, citing the monetary authority’s weekly survey with analysts. “This should maintain the COPOM’s 2025 inflation projection at more or less 3.2%, which would not represent a sharp worsening of the scenario expected by the policymakers.”
In addition, in recent weeks, current inflation in Brazil has shown positive surprises, with core indicators remaining subdued. Thus, despite the factors indicating that there would still be room for a 50-bp cut, the COPOM is likely to deliver a more modest reduction in interest rates, in the economist’s view.
“The Central Bank’s communication led the market to believe that it prefers a 25-bp cut. I understand the 25-bp level as a tactical option to buy time as the global scenario has changed and the Fed’s interest rate cuts have been postponed. But the Central Bank should continue to indicate that there is still room for monetary easing. It wouldn’t make sense for it to cut 25 bp and send a signal that the cycle is coming to an end. There is still room for more monetary easing,” said Mr. Honorato.
The chief economist at Banco BV, Roberto Padovani, argues that the “last mile” of the global disinflation process should cause costs to the activity. This suggests a potential slowdown in the U.S. economy due to monetary constraints. Coupled with sluggish growth in Asia and Europe, it could lead to lower commodity prices.
“Furthermore, we believe that the real interest rate in Brazil is excessively high, and we see no reason to slow down the pace of cuts at this time. As the global environment is disinflationary, the risks are lower,” said Mr. Padovani, who maintains a 50-bp cut as his baseline cenario.
According to Ivo Chermont, the chief economist of Quantitas, the Central Bank has strongly suggested that it will cut the Selic by 25 bp. “Campos Neto did not appear relaxed at all about the fiscal situation, and there have been no recent changes on that front. The exchange rate volatility regime has shifted, making it impossible to trust that the current screen price is the new normal, and that reflects the global scenario’s volatility. Additionally, inflation expectations have increased, which is likely to concern the Central Bank even more. Why would Campos Neto take the cost of being tough and give a 50-bp cut?” said Mr. Chermont.
*Por Gabriel Roca, Victor Rezende — São Paulo
Source: Valor International