The main divergence we have emphasized is in monetary policy trajectories. The first phase, which began late last year and will run through this month is other countries taking action to ease policy. The Fed stood pat. The second phase is when the Fed lifts rates and many others continue to ease, perhaps at an accelerated rate.
Markets reacted positively to the news of Levy’s replacement. Why, given that Levy is seen as one of the few anchors of sound economic policy of this government? Here are two possible reasons: 1) If Levy goes, which looks likely at some point anyway, Meirelles is better than any other visible candidate; and 2) Meirelles would have the full support from Lula, which some say is engineering this move.
Let’s look at two arguments separately.
1) Meirelles’ credentials. He was seen as very hawkish and an anchor of orthodox macroeconomic policy during the Lula government. At the helm of the central bank (2003-2011) he embarked on three monetary policy tightening cycles, all of which resulted in “lower highs and lower lows.” Speaking of orthodox credentials, his latest blog post just a few days ago stated that: “This new global picture shows how [Brazil’s] economic development will only be sustainable with fiscal responsibility and basic economic reforms targeting increase in productivity and competitiveness…” (Our translation). In addition, local news reports say that if he were to accept the job, he would demand a great degree of independence to implement policies.
2) Support of former President Lula. According to the rumor mill, Meirelles is being planted by Lula. Let’s take this as axiom for the sake of the argument. The advantage of a Lula appointment is that it would make the government’s relationship with the more leftist wing of the PT (and other parties) less acrimonious. The assumption here is that Lula has nearly infinite political capital within the PT, which largely depends on him for its post-Dilma future. So Meirelles would have more degrees of freedom to implement tough policies. The more conspiratorial side of the story sees the appointment of Meirelles as effectively marking the start of Lula’s 3rd term as president and a landmark moment of Dilma’s decline in power.
Our view: We think markets are overestimating the odds of the Levy-Meirelles swap. That said, the trial balloon this week could turn out to be a self-fulfilling prophecy. In other words, Dilma was not convinced about appointing Meirelles, but seeing the positive market reaction, she could become more favorable towards it. Still, we caution against jumping on a Meirelles-based rally on the back of further rumors – the situation is fluid and far from certain. Best to wait and see, in our view. The only certainty now is that should Levy be replaced by any obvious PT-friendly name that is not Meirelles, there will be a massive sell-off. So the risks to Brazilian assets, at least as it pertains to this event, seem very asymmetric to the downside.