CONCLUSION: The timing of our bullish thesis on Brazilian equities has been delayed as a result of the accumulation of negative effects stemming from the recent slew of policy maneuvers. We’ll likely revisit Brazil on the long side in the coming months, but, for now, we expect continued lower-highs in the BRL (vs. the USD) and Brazilian equities on a TRADE and TREND basis.
In our MAY 23 note titled “WERE WE SIMPLY TOO EARLY OR JUST PLAIN WRONG ON BRAZIL?” we wrote:
“… we can’t stress this enough: we expect both Brazil’s equity market and currency to experience continued downside over the intermediate term post the MAY 29-30 central bank meeting if their actions are perceived to be in line with the broader central plan of Brazilian policymakers. The strongest TREND-duration short thesis for Brazilian equities (i.e. the opposite of our long thesis) is quite consensus at this juncture, given that the Bovespa Index has indeed crashed from its MAR 13 YTD high (-20.1%).
Shorting Brazil from here requires true guts, but if the USD continues to make higher-highs over the intermediate-term – dragging cross-asset volatility up alongside it (the two are +94% correlated on an immediate-term duration) – Brazilian equities and the Brazilian real will likely continue to get tattooed if policymakers don’t commit to providing international investors with higher rates of expected return(s) via doing what they must to stem the tide/reverse the trend in the exchange rate (i.e. selling dollars, lowering cross-border IOF taxes, introducing a rhetorical floor for the BRL, hiking rates [not likely], etc.).”
Upon analyzing today’s -50bps SELIC Rate cut and associated COPOM commentary, it’s clear to us that Brazilian officials have no desire to protect the nation’s currency from capital flight associated with the latest King Dollar breakout – a phenomenon only exacerbated by the recent spate of increased capital controls and advance of the sovereign further into the Brazilian financial markets.
The benchmark SELIC Rate has now been reduced to an all-time low of 8.5% on the strength of a consensus decision by the COPOM (129 of 154 decisions) – which is the first to be publically disclosed on an individual basis under the new statue. While don’t have their full minutes (to be released on JUN 8), we feel comfortable in saying their latest guidance is more dovish than their previous statement – which, inadvertently or explicitly, is in line with Rousseff and Mantega’s desires for a structurally lower domestic cost of capital and a weaker currency (generally at the expense of the Brazilian private sector and foreign investors):
- APR: “… even considering that the activity recovery has occurred more slowly than anticipated, the Committee believes that, given the cumulative and lagged effects of policy actions implemented so far [i.e. 350bps of rate cuts], any movement of additional monetary easing should be conducted with parsimony.”
- MAY: “The COPOM considers that, at the moment, the risks to the inflation trajectory are limited. The committee also notes that, until now, given the fragility of the global economy, the contribution of the external sector has been disinflationary. Given this, and giving continuity to the adjustment process of monetary conditions, the COPOM decided to reduce the SELIC rate to 8.5 percent per year without a bias.”
As such, we are no longer inclined to trade Brazilian equities with a bullish bias over the intermediate term (though we wouldn’t fight the onset of an unhealthy, centrally planned asset price pop out of the FED if one were to occur). While Brazil’s TREND-duration GROWTH and INFLATION outlooks continue to be supportive of a 2H12 rebound in both the currency and equity market, poor POLICY should continue weigh the BRL and the Bovespa over the immediate-to-intermediate term.
While we wouldn’t recommend shorting and holding Brazilian equities from here (the Bovespa has experienced a -21.8% YTD peak-to-present crash), we do find it prudent to wait and watch for quantitative confirmation of an immediate-term TRADE breakout or confirmation that the index won’t break down through its AUG ’11 lows before dabbling on the long side again.
Deflating the Inflation only works to stimulate economic output only if a country’s currency remains relatively strong enough to reap the benefit of the disinflationary forces – particularly in an economy like Brazil, which is simply laden with structural inflationary pressures (email us for our TAIL duration AUG ’11 Brazil Black Book). Brazil’s disinflationary tailwind stemming from our initial Deflating the Inflation theme (APR ’11) peaked in FEB and should continue be a headwind on the margin through at least SEPT (holding current market prices flat through year-end).
All told, the timing of our bullish thesis on Brazilian equities has been delayed as a result of the accumulation of negative effects stemming from the recent slew of policy maneuvers. We’ll likely revisit Brazil on the long side in the coming months, but, for now, we expect continued lower-highs in the BRL (vs. the USD) and Brazilian equities on a TRADE and TREND basis. Alas, POLICY remains the hardest factor to model – though arguably the most important to get right in today’s Global Macro environment.