Close Call on Brazil Today

Brazil's central bank meets today and surveys suggest the market is nearly evenly divided over the outlook. Strong growth and rising inflation and inflation expectations requires a rate hike and the issue is whether the central bank goes today or waits a month to lift the overnight Selic rate which currently stands at 8.75%.

The case for the rate hike is that as officials recognize Brazil is enjoying a "vigorous expansion." Last week, the government reported a record 2.7% rise in January retail sales, for example. At the same time, inflation is rising faster than expected and the central bank survey from earlier this week, found inflation forecasts also rising. If rates have to rise, there seems little to be achieved by waiting another month.

The case against a rate hike today is largely about politics. There is speculation that this may be the Meirelles's, the central bank governor, last meeting. Local press reports suggest he may resign so as to qualify for vice president candidate under Dilma Rousseff, the head of the cabinet and Lula's hand picked successor. Meirelles generally receive high marks for his performance at the central bank and would add extra economic gravitas to Dilma's campaign. Meirelles is required to step down by April 2nd if he is to participate in the Oct elections.

There is speculation that the current director of financial regulation at the central bank Tombini replaces Meirelles. The latest polls show Dilma, who has trailed behind Serra, narrowing the gap. There are some ideas that the government may have held back some fiscal expenditures to help goose the economy before the election, but the recent strength of the economy suggest such extra fiscal push is not needed.

While we recognize the possibility of a rate hike today, we suspect the more likely scenario is a split decision to keep rates steady today, which would boost expectations for at least a 25 bp move if not greater at the April COPOM meeting. Alternatively, Meirelles does in fact resign in the coming weeks, the risk of an April move, regardless of the outcome today, would seem to increase.

After climbing to BRL1.90 earlier in Q1 amid a widespread bout of profit-taking on emerging markets and commodities in general, the US dollar has slipped back to the BRL1.75. There does appear to be some support here, but we look for a test on better support close to BRL1.70.

In terms of flows, anecdotal and proprietary data suggests that foreign capital inflows into Brazil are being dominated by yield considerations and is drawn to the fixed income instruments, rather than commodities and equities. The US S&P 500 is outperforming Brazil's Bovespa this year. The Bovespa however, is doing better than China and India, though Russia is the best performing equity market among the BRICs.
Close Call on Brazil Today Close Call on Brazil Today Reviewed by Marc Chandler on March 17, 2010 Rating: 5
Powered by Blogger.