COPOM Preview

Markets are unanimous in calling for the COPOM to keep rates on hold at 14.25% this Wednesday, so the tone of the statement will be the focus.

It is still unclear whether we have reached the end of the tightening cycle. Our view is that it depends on what happens to the real, but we think that the bar is very high for a hike this year or even at the start of next year.

First let’s look at where markets are. The official central bank survey (FOCUS) shows that participants expect, on average, for rates to remain unchanged this year, but then rise by 50 bp. Implied rates on local swap contracts are showing a lot more hikes priced in than that, somewhere around 100 bp. Of course much of this is risk premium and volatility of the swap instrument itself, but it still reflects some of the uncertainty in the outlook.

We side more with the survey, and even then we are not so convinced. The economy is going to contract some 3.0% this year and most likely remain in negative territory for 2016. Inflation should converge towards the upper limit of the target range at 6.5% from nearly 10% this year. And there will be a lot of political pressure not to hike rates further from the government’s party PT. This is especially the case since President Rousseff is likely to resist calls to change the economic team and remove Finance Minister Levy – so having a hawkish central bank will aggravate her standing with the left.

But most importantly, we think the move in BRL will not warrant a hike for two reasons. First, the central bank has demonstrated a clear preference to use FX-related tools to deal with FX issues, instead of using interest rates as, for example, Russia and Turkey have done not too long ago. Second, while we think the depreciation pressure on the real is likely to persist, the worst is over in our view. Unless we get an extraordinary domestic or external shock, we think volatility and the speed of the currency moves will decline. This will reduce the need for a “shock” interest rate hike to anchor FX expectations.