Eye On Brazilian Policy: “Oh No You Didn’t”

Conclusion: We view the central bank’s aggressive and proactive rate cut as supportive of Brazilian equities because it will likely coincide with a peaking of CPI and a deceleration in Brazil’s current economic slowdown. Our quant models aren’t in full confirmation of this, however, which suggests the turn is likely further out in duration. From a longer-term perspective, Rousseff’s recently unveiled 2012 budget proposal is flat-out awful for the Brazilian economy.

 

Yesterday evening, Banco Central do Brasil’s monetary policy committee (COPOM) “surprised” economists by cutting the country’s benchmark interest rate, the Selic, -50bps to 12%. We used quotations around the word surprised because the move wasn’t very surprising at all. Brazil’s bond market, interest rate swaps market, and, perhaps most importantly, Brazilian officials have been signaling to us for at least the last the last few weeks that a rate cut was definitely in play – despite the fact that the country’s latest CPI reading came in at a six-year high of +6.9% YoY (40bps above the upper threshold band around the central bank’s target of +4.5%).

 

As we pointed out in our Weekly Latin America Risk Monitor on August 22nd:

 

“The big callout in Latin American fixed income markets is the -50bps wk/wk decline in Brazilian 2yr sovereign debt yields as expectations for future interest rate cuts continue to get priced into Brazil’s interest rate market (1yr on-shore swap rates declined -37bps wk/wk and -95bps MoM). Interestingly, Friday’s closing [2yr] yield of 11.54% is a full 96bps below the Brazilian central bank’s benchmark interest rate (the Selic).”

 

Eye On Brazilian Policy: “Oh No You Didn’t” - 1

 

On the political pressure front, we offer the following collection of recent quotes and sound bites originating from Brazilian policymakers if nothing more than to highlight how telegraphed and politically motivated last night’s rate cut decision was: 

  • “The central bank’s fight against inflation is being backed by fiscal policy.” – Central Bank President Alexandre Tombini on Aug. 1.
  • “Creating conditions to cut interest rates in Brazil is a priority… Lower rates would be very healthy because they would cut the cost of servicing the nation’s debt.” – Finance Minister Guido Mantega on Aug. 23.
  • “Brazil plans to halt a rise in government spending this year to prepare Latin America’s biggest economy for a global slowdown and make room for a cut in interest rates… As you reduce or stop increasing public spending, you open space for a reduction in interest rates when the central bank thinks it is possible.” – Finance Minister Guido Mantega on Aug. 29. (to Matega’s credit, Brazil did recently revise up its target for its 2011 primary surplus +11.4% to R$91B ($57B), though largely on aggressive measures to widen the tax base among consumers and corporations alike – as opposed to more traditional measures of austerity)
  • “The country’s interest rates should begin to fall as the government reduces spending… We want, starting now, to have lower interest rates on the horizon.” – President Dilma Rousseff on Aug. 29
  • “Brazil is anxiously awaiting a decline in the country’s interest rates… We are all anxious to see the moment when the rate of interest will drop... The government’s fiscal efforts may create the conditions for rates to fall in the very near future.” – Trade Minister Fernando Pimentel on Aug 30.

 

Needless to say, the central bank’s autonomy is being called into question. While this is certainly not the forum to debate the proper relationship between officials who determine monetary policy and those that determine govern the broader economy, the interplay in Brazil is one worth highlighting. To that tune, check out the notes regarding this subject below, which were compiled from various sources in the Brazilian press by Moshe Silver, Chief Compliance Officer and Managing Director here at Hedgeye: 

  • President Rousseff and her PT party hailed the rate cut, PSDB party opposition politicians say the central bank was afraid of President Rousseff and caved in to her politicized demand.
  • Former central bank president Carlos Langoni says the COPOM decision is a “daring” move that calls the central bank’s credibility into question and needs to be much better explained.
  • Yesterday’s COPOM meeting dragged on for an unusually long four hours, and two directors voted against the decision. 

It will be interesting to see whether or not Tombini and his divided board are jumping the gun. As we alluded to earlier with headline CPI currently running at a six-year high, inflation is not tamed within Brazil. Moreover, the most recent inflation-related data points would suggest that price pressures could indeed be increasing on the margin: 1) IBGE IPCA-15 CPI accelerated in Aug. to +27bps MoM; and 2) FGV IGP-M CPI accelerated in Aug. to +44bps MoM. We do, however, expect YoY headline CPI to peak in August and begin slowing like the most recent IGP-M print, which decelerated to +8% YoY (vs. +8.4% prior). Tombini’s models echo that of our own, saying recently, “Policymakers are more comfortable with inflation because annual price increases will slow starting in September.”

 

It certainly is unusual for a central bank to be this aggressive – particularly when the data has not yet confirmed their outlook. Specifically, the last time the global economy was this close to the precipice, Banco Central do Brasil waited patiently for confirming data to cut interest rates (over four months after the collapse of Lehman Bros). Interestingly, President Rousseff said in early Aug. that the Brazilian economy was “stronger that it was at the time of the Lehman bankruptcy” and that the country has “the necessary conditions to meet the global economic crisis”. Given yesterday’s aggressive maneuver out of the Brazilian central bank, perhaps they believe the Global Macro environment will deteriorate faster than they had originally anticipated and far worse than what we saw in the Lehman aftermath. Something to keep in mind there as it relates to “what people are saying out there”…

 

Their aggressiveness this time around could be a good thing or it could be a bad thing, particularly if inflation expectations increase and push up the long end of Brazil’s interest rate curve – which it did not do today (in fact, Brazil’s benchmark 9yr bond yield has fallen -17bps day/day). Regardless, we commend Banco Central do Brasil for having conviction in their process and being daring enough to step outside the box and help the ailing Brazilian economy with an “unsuspected” rate cut. Furthermore, analysis of their accompanying statement would suggest that they truly believe a rate cut was warranted – as opposed to being merely politically motivated: 

  • “Re-evaluating the international scenario, the Copom considers there was a substantial deterioration consisting of, for example, a generalized reduction of great magnitude in the growth projections for the principal economic blocs.”
  • “It also notes that, in these economies, the space to use monetary policy is limited and the outlook is one of fiscal restrictions. “
  • “In this way, the Committee evaluates that the international scenario shows a disinflationary bias in the relevant time period.” 

It is important to highlight how their outlook for the global economy stands counter to the bullish storytelling within our domestic institutional investment community.

 

As it relates to the Brazilian economy at large, it will be interesting to see if this is an inflection point in Brazil’s economic cycle or merely a catalyst for a deceleration in the current slowdown. Our models point to the latter, and that may explain why the Bovespa index is still broken from a TREND and TAIL perspective, despite a +14.4% melt-up “off the lows”. It will pay to wait to see if the Bovespa breaks out and holds above its critical TREND line of resistance. If that happens, we think this market trades between 59,765 and 66,303 over the intermediate term. A breakout above the TAIL line would be incredibly bullish indeed and would likely coincide with more aggressive rate cutting.

 

Eye On Brazilian Policy: “Oh No You Didn’t” - 2

 

On the subject of cutting, Brazilian policymakers “did it again” with regards to hyping up budget cuts and falling well short of the expectations they set with the Brazilian public. Yesterday, President Rousseff’s 2012 budget proposal was introduced and, needless to say, it’s rife with accounting tricks and aggressive assumptions that makes the administration appear more fiscally conservative than it is actually being.

 

In fact, this budget is actually seeking to “increase” the country’s primary surplus to R$140B from the projected R$128B. This does, however, include an accounting buffer that will allow it to discount R$40B, per Budget Minster Miriam Belchior. Without the accounting buffer, which Belchior publicly admits the administration would prefer not to use, the country’s primary surplus is expected to decline -21.8% next year.

 

Other key highlights from Rousseff’s budget proposal include: 

  • A +13.6% increase in the minimum wage and pension outlays;
  • A +15% increase in healthcare spending;
  • A +33% increase in education related outlays;
  • A +300% increase in social welfare spending; and
  • A GDP growth projection of +5% YoY (vs. Bloomberg consensus 2012E of +4%). 

We’ve been very critical of her administration’s budgeting gimmicks in past notes, so, for now, we’ll grant her the benefit of the doubt and reserve the bulk of our judgment for when/if the budget is actually ratified by the Brazilian Congress. Were the budget to become enacted as it stands currently, we believe it would be bearish for the country’s real economic growth over the long-term TAIL (higher rates of inflation).

 

All told, we view the central bank’s aggressive and proactive rate cut as supportive of Brazilian equities because it will likely coincide with a peaking of CPI and a deceleration in Brazil’s current economic slowdown. Our quant models aren’t in full confirmation of this, however, which suggests the turn is likely further out in duration. From a longer-term perspective, Rousseff’s recently unveiled 2012 budget proposal is flat-out awful for the Brazilian economy.

 

Darius Dale

Analyst


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