Schroders' co-head of Emerging Market Debt Relative Return, James Barrineau, comments on Brazil's decision to hike rates to 11%.
Schroders’ co-head of Emerging Market Debt Relative Return, James Barrineau, comments on Brazil’s decision to hike rates to 11%.
Yesterday Brazil’s central bank signaled what is likely to be the end of its long rate-hiking cycle by significantly changing the language in its communique while unanimously hiking rates by 25 basis points to 11%.
Whereas the central bank had been careful to frame previous hikes as part of a continuing adjustment process, the language at this meeting dropped that stipulation and signaled that further hikes would be data dependent. Our view is that the central bank will be extremely reluctant to raise rates further and only a sharp deterioration in either market sentiment or inflation would force its hand.
The decision comes in the context of a less volatile environment both overall in emerging markets and for Brazil in particular. The markets calmly digested a credit downgrade by S&P last month. The country was given a stable outlook and the agency suggested that a further downgrade was unlikely for an extended period, if at all, thus avoiding a worst case scenario of a rating cut with a negative outlook that might signal the end of investment-grade status for the country.
Currency volatility had been declining as the currency slowly appreciated since falling to its lowest level versus the dollar in early February. This week, the central bank also signaled that it would begin to gingerly withdraw its ongoing intervention in the currency market which we take as a positive signal of the bank’s confidence that the worst is over.
With three year Brazilian local bonds offering a 12.5% yield, local rates are very attractive in an environment of slowly healing emerging markets sentiment. We think the market has been too pessimistic about further rate hikes, and as the October presidential election gets closer the central bank will almost certainly head to the sidelines. Absent a substantially negative inflation surprise, which seems unlikely with sluggish growth and a steady currency, we would expect rates to begin to creep lower, as confidence grows that the hiking cycle is indeed over.