Jun 21 / Alef Dias

Macroeconomics Weekly Report - 20240621

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Even with Copom's unanimous decision, fiscal policy continues to weigh on the BRL

  • The unanimous maintenance of the interest rate and the post-meeting communiqué - released last Wednesday (19) - suggest that Brazil's Central Bank (BCB) may leave the Selic rate as it is for longer than analysts expect.
  • We believe that the BCB's statement was less hawkish than the markets had expected, which could weigh on the currency. In addition, the market has reacted negatively to fiscal policy measures and news, discouraging expectations of a stability of Brazil's public debt.
  • Added to this is the appreciation of the dollar on the international stage and the acceleration of inflation and slowdown in economic activity on the domestic stage, contributing to a negative outlook for the BRL in the coming months - even considering the already strong devaluation observed in 2024.

Introduction

The unanimous maintenance of the interest rate and the post-meeting communiqué - released last Wednesday (19) - suggest that Brazil's Central Bank (BCB) may leave the Selic rate as it is for longer than analysts expect. At the same time, this does not indicate that policymakers are considering the rate increases that were priced into the yield curve.

We believe that BCB's statement was less hawkish than the markets had expected, which could weigh on the currency. In addition, the market has reacted negatively to fiscal policy measures and news, discouraging expectations of a stability of Brazil's public debt. Recent activity and inflation data have also increased the negativity towards the Brazilian currency. In this report we will address these issues and update our outlook for the BRL.

Image 1: USD/BRL and Emerging Currencies Index

Source: Refinitiv

Image 2:  Interest Rate Curve - Brazil (%)

Source: Bloomberg

Unanimity reduces risks of changes in monetary policy

The BCB's Monetary Policy Committee (Copom) kept the Selic rate at 10.50% on Wednesday, in line with our expectations and the consensus of analysts. The vote was unanimous. This measure interrupted the easing cycle that began in August. The BCB had cut the rate by 325 basis points in seven consecutive meetings.

Monetary policy remains restrictive. The real ex-ante rate - which is discounted by expected inflation over 12 months - is 6.6%, well above the neutral level of 4.5% that the BCB has assumed since the beginning of 2022.

In our opinion, the statement tried to convey that the BCB will keep rates at the current level for as long as necessary to consolidate the disinflation process and anchor inflation expectations. The statement said that if rates remained stable until the end of 2025 - instead of being cut to 9.5%, as analysts expect - inflation would end next year only slightly above the 3% target.

The markets received the unity around the decision and the statement positively - the yield curve erased some of the interest rate increases that were priced in before the meeting. Even so, we understand that this will not be enough to control inflation expectations.


Image 3: Interest rate - Brazil (%)

Source: Bloomberg

Inflation and activity worry

Last week's inflation and activity data also brought more fragility to the Real. Brazilian inflation accelerated to 3.93% year-on-year in May from 3.69% in April, remaining above the 3% target but within the tolerance range of +/- 1.5 percentage points. Bloomberg's inflation decomposition model suggests that the increase can be attributed mainly to deteriorating supply conditions and slightly stronger demand.

Not only has inflation accelerated, but inflationary expectations have also deteriorated since mid-April, which has also contributed to the devaluation of the Brazilian currency, and the expectation of a more expansionary fiscal policy has been the main factor contributing to this phenomenon.

With regard to activity, the IBC-Br was stable in April compared to March, against a consensus estimate of 0.3% growth, reinforcing the view that the Brazilian economy is slowing down. The continuation of the restrictive monetary policy and the impact of the floods in the south of the country should help to maintain this trend

Image 4: Accumulated CPI

Sources: Refinitiv

The trajectory of public debt is worrying

Market analysts heard monthly by the Ministry of Finance's Economic Policy Secretariat (SPE) project that the government will deliver a primary deficit of R$79.715 billion in 2024. The estimate is worse than the previous document from May, which projected a deficit of R$76.825 billion.

The government intended to bring the deficit to zero this year with the new fiscal framework approved last year. Although the 2024 Annual Budget Law foresaw a small surplus of R$2.8 billion in 2024, within the desired neutral result, the bimonthly expenditure and revenue report released in May revised the primary result to a deficit of R$14.5 billion (equivalent to 0.1% of GDP).

For 2025, the projection has also worsened: the market expects a deficit of R$90.134 billion, compared to R$87.458 billion the previous month. As we commented in previous reports, the government changed the fiscal target for 2025 when it sent the budget guidelines bill (PLDO) to Congress: from a surplus equivalent to 0.5% of Gross Domestic Product (GDP) next year, the target is now to repeat the neutral result of 0% of GDP.

The trajectory of the public debt continues to be one of the most relevant factors for the Real's exchange rate, and even with the strong recent devaluation, there is still room for further weakening of the Brazilian currency if the government doesn't move forward with plans to review public spending. Increased tax collection may be one way out, but society has shown increasing resistance to these projects - increasing their political costs.

Image 5: Gross General Government Debt and Net Public Sector Debt - Brazil (% of GDP) 

Sources: Refinitiv

In Summary

Although it was well received by the market, the unanimity surrounding the latest Copom decision should have little impact on the Real's current situation. The outlook for fiscal results continues to deteriorate while the central government continues to make little or no progress on agendas to reverse this situation, especially on the spending cut front.

Added to this is the appreciation of the dollar on the international stage and the acceleration of inflation and slowdown in economic activity on the domestic stage, contributing to a negative outlook for the BRL in the coming months - even considering the already strong devaluation observed in 2024.

Weekly Report — Macro

Written by Alef Dias
alef.dias@hedgepointglobal.com
Reviewed by Victor Arduin
victor.arduin@hedgepointglobal.com
www.hedgepointglobal.com

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