Aug 14 / Alef Dias

Macroeconomics Weekly Report - 2023 08 14

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"Despite a significant part of the market expecting the more aggressive cut, the post-decision reaction was still strong. Interest rates fell significantly and the Real depreciated strongly - given that lower interest rates tend to reduce the attractiveness of short-term investments (measured by the Return on Carry Trade, for example), leading to an outflow of foreign capital."

Fundamentals still point to optimism with the BRL

  • Brazilian monetary policy has undergone significant changes in recent weeks, with the start of the interest rate cut cycle by Brazil's Central Bank (BCB).
  • Expectations were divided between 25 and 50 basis points (bps), and the decision for the 50-bps cut to 13.25% was not unanimous and was accompanied by a more "cautious" stance from the BCB in its post-decision statements.
  • Looking forward, we have fundamentals that should prevent further BRL devaluations. The BCB aims to keep real interest rates above the "neutral" level, suggesting moderate cuts ahead. Additionally, inflation expectations are falling, the Brazilian trade balance continues to show significant surpluses, and speculators remain optimistic about the Real.
  • However, our Real Fair Value model - which uses the DXY, BCOM, the interest rate differential and the Brazilian CDS as variables - shows that the Brazilian currency looks well priced at the moment.

Introduction

The last few weeks have been extremely remarkable and relevant for Brazilian monetary policy. Lower inflation expectations in recent months and less uncertainty regarding fiscal policy finally led the Central Bank of Brazil (BCB) to start the long-awaited interest rate cut cycle.

Market expectations were well divided between a 25 bps and 50 bps cut ahead of last week's COPOM meeting. The decision for a 50-bps cut to 13.25% p.a. was not unanimous and the BCB adopted more hawkish language in the post-decision statement and meeting minutes, aiming to curb bets on larger cuts at future meetings.

After this important event and all the post-decision communication from COPOM, we will update our outlook for the Brazilian economy and the Real in this report.

Image 1: USD/BRL – Spot and Fair Value

Source: hEDGEpoint, Bloomberg

Image 2: Inflation Expectations – Brazil (%)

Source: Bloomberg

Although expected, the cut had relevant impacts

Despite a significant part of the market expecting the more aggressive cut, the post-decision reaction was still strong. Interest rates fell significantly and the Real depreciated strongly - given that lower interest rates tend to reduce the attractiveness of short-term investments (measured by the Return on Carry Trade, for example), leading to an outflow of foreign capital.

However, we still see several positive fundamentals for the Real that should prevent further currency devaluations in the medium to long term.

Even with a 50-bps rate cut, Brazil remains far from the neutral real rate of 4.5%

The BCB emphasized a "firm objective of maintaining a contractionary monetary policy to re-anchor expectations and bring inflation to the target over the relevant horizon", so we do not expect Brazil to accelerate the pace of cuts in the coming meetings, maintaining the attractiveness of real interest rates against central economies for quite some time.

Image 3: Carry Trade Returns (EMs)

Source: Bloomberg

In addition, the country continues to show extremely positive results in the trade balance. The surplus in July was the largest since 1989, and since March this year, the surplus has been below 5-year highs only once. Additionally, speculators remain very bullish on the BRL, net long above 5-year highs.

In Summary

Looking at our Fair Value model of the Real - which takes the DXY, BCOM, the interest rate differential, and the Brazilian CDS as variables - the Brazilian currency looks well priced at the moment. However, inflation expectations have been decelerating rapidly and the BCB has shown that it is unlikely to accelerate the pace of interest rate cuts in the coming meetings.

Additionally, there is a positive trade balance and the possibility of a CDS reduction as the Brazilian government's macro and microeconomic reform agenda advances - which, even if imperfect, could reduce Brazil's fiscal risk. Therefore, looking at domestic fundamentals, the appreciation of the Real seems more likely.

Image 4: Selic rate and real rates - Brazil (%)

Source: Bloomberg

In Summary

Analysts are already beginning to question China's conditions for reaching the official 5% growth target for the year 2023. The central problem for the country today is how to rescue consumer confidence and create conditions for its real estate market to recover. Due to the importance of the segment for the country's economy, its poor performance ends up affecting other sectors such as industry, which slowed down in July.

While the rate cuts are an important signal to the market, China needs more stimulus to boost its slowing economy. Some events are raising more concerns about the risks facing the country. The defaults announced by major real estate companies are an example, and the Country Garden case, despite being recent, may not have been the last.

The continuity of the Chinese slowdown contributed to a more challenging macro scenario for commodities and emerging currencies, given that the country is the main importer of several products and one of the main trading partners of several emerging countries.

Weekly Report — Macro

Written by Alef Dias
[email protected]
Reviewed by Pedro Schicchi
[email protected]
www.hedgepointglobal.com

Disclaimer

This document has been prepared by hEDGEpoint Global Markets LLC and its affiliates ("HPGM") exclusively for informational and instructional purposes, without the purpose of creating obligations or commitments with third parties, and is not intended to promote an offer, or solicitation of an offer, to sell or buy any securities or investment products. HPGM and its associates expressly disclaim any use of the information contained herein that may result in direct or indirect damage of any kind. If you have any questions that are not resolved in the first instance of contact with the client ([email protected]), please contact our internal ombudsman channel ([email protected]) or 0800-878-8408 (for clients in Brazil only).

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