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quinta-feira, abril 19, 2012

Central Bank cuts rates by 75 bps and leaves door open for further cuts

Brazil Monetary Policy

Central Bank cuts rates by 75 bps and leaves door open for further cuts

Facts

The monetary policy committee (Copom) of Brazil’s Central Bank cut the Selic policy rate by 75 bps, to 9% in line with market expectations. Our impression is that the statement published after the meeting (our translation below) leaves the door wide open for further cuts.

“The Copom considers that risks to the trajectory of inflation remain limited at this moment. The Committee also notes that to date, given the fragility of the global economy, the contribution of the external scenario has been deflationary. In light of this, continuing the process of adjustment of monetary conditions, the Copom unanimously decided to reduce the Selic rate to 9%, without bias.”

Economics View

In our view, the statement strongly hints at more interest rate cuts in the pipeline. The Central Bank states that inflationary risks are limited and that the external backdrop has been deflationary. Perhaps most strikingly, it retained the phrase “continuing the process of adjustment of monetary conditions”, which may be interpreted by investors as a suggestion that the adjustment process is still ongoing. This is contrary to what we had expected. Considering the deterioration of long-term inflation expectations and the direct language used by the Central Bank to signal that 9% would be an appropriate level for interest rates, we expected the Central Bank to make it clear they intended to end the easing cycle.

We therefore attribute a higher probability to further interest rate cuts in May. That said, after March, when a dovish surprise at the COPOM meeting (the 75 bps cut) was followed by minutes that were considered hawkish, investors should be cautious in interpreting the Central Bank’s language in the statement, which we believe requires clarification in minutes of the meeting (to be published next week on 26 April).

Fixed Income Strategy view

Going into the April meeting, the front end of the curve prices was pricing in a 75bp cut with about 70% probability relative to a 50bp move. Based on this alone, we would expect the front end of the DI curve to rally 5-8bps all things equal. In addition, we believe it is likely that the market will take the statement as an indication that COPOM is willing to take the SELIC even lower from here. A SELIC level of 8.75% is already priced in, but we see room for the front end to price in a move towards 8.50% with some probability. In that sense, we believe that bullish sentiment will prevail in the near term. The COPOM minutes next week will give us better guidance as to how far implied pricing should go. Our bias remains for a steeper curve overall.

FX Strategy View

The possibility that the COPOM could continue cutting rates below 9% adds additional headwinds to an already poor near-term BRL outlook. As a signal, further cuts would reassert the perceived increased coordination between monetary and FX policy and thus reaffirm the “intervention premium” with which the BRL has been trading relative peers. From a pure carry perspective, the prospect of lower interest rate differentials becomes more sensitive at a time when onshore dollar rates are shooting higher. Until recently, BRL NDF implied yields had maintained a rising trend despite the BCB’s easing cycle because strong dollar inflows were keeping onshore dollar rates depressed. However, in recent weeks FX inflows have subsided while the BCB has increased its spot purchases reducing the supply of USD in the system. As a result, onshore dollar rates have spiked over 100bp in the 1 mo. FRA contract month-to-date while BRL NDF 1 mo implied yields have contracted by 200bp to c6.5%. The combination of lower carry, higher volatility, still uncertain monetary policy path, and sustained intervention risk keeps the bias for the price action on USD-BRL still on the upside, in our view. We maintain a neutral-to-bearish view short term but would be looking at improving valuations to open new opportunities for a correction play. What we think: As expected, the Central Bank cut the Selic rate by 75 bps. The language of the statement was more dovish than was anticipated, leaves the door open for further easing and, in our view, requires clarification in the minutes. The statement may support bullish sentiment in the short end of the DI curve, but seems bearish for the BRL.

Constantin Jancsó (Economist), Gordian Kemen (Strategist) and Marjorie Hernandez (Strategist) 
Source: HSBC

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