Expectations for Rate Cuts in Brazil Pick Up Steam

Let’s recall that only a few months ago most viewed prospects for a Brazil rebound as somewhere between dead cat bounce and hopium. Most institutional investors missed the late Fall 2015 signs of a bottom being put in; then in February 2016 they sat waiting for the “floor” to drop out; finally, in June, they said that it wouldn’t last, that Brazil is doomed. We literally had pension investors telling us in July that Brazil was going to sell off hard, again. And this was well after the massive political upheaval and decided improvement in forward-looking macro data – especially trade, FDI and inflation. Well, how things change.

Our view towards Brazil shifted materially last Fall when it became apparent the correlation between EM FX and the USD started to break down. Following the January swoon, the time to buy was clearly staring right into our eyes. Fast forward, it’s pretty clear that when forward looking macro indicators started showing material improvement in Q2, combined with Dilma’s ouster, the inflection point had arrived.

Over the last several months, expectations for rate cuts have gained momentum and with YoY CPI now trending decidedly lower, most believe the central bank will cut as early as the end of October.

“DJ Brazil’s Central Bank Might Cut Aggressively — Dow Jones – Tue Oct 11 09:06:25 2016 EDT

The initial approval by Brazil’s lower house of a proposed constitutional amendment on taming government
spending paves the way for fast and aggressive interest-rate cuts, says Cristiano Oliveira, chief economist at Banco
Fibra. He expects the Selic to be slashed some 5 percentage points the next year from the current 14.25%. Central-bank
officials next meet next week.

While we don’t expect 500bps of cuts in 2017, it is certainly possible, but Brazil does have an inflation issue and it will be a while before we can really measure its progress in the post-commodity global paradigm. Our view is we’ll get a 25bps to 50bps cut either at the next meeting in a couple of weeks or next month and then it will be wait-and-see for inflation. The Fed’s lower for longer policy removes some of the Brazil central bank’s urgency to see growth rebound at the expense of moving too fast, too soon. For 2017, we continue to think a reasonable expectation would be for 200bps to 300bps in rate cuts.