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Brazilian Rates Rising, Capital Flying Down To Rio

Friday January 21st 2011

In our  “Global Outlook 2011”, see www.spotlightideas.net, we wrote;
“…In 2011 the general view is that inflation will gather pace driven by higher food costs. CPI is set to rise by 5.15% which is higher than the June estimate of 5.05%. This reflects the fact that the largest economy in Latin America will expand at the fastest pace in 20 years. … CPI will be within the target of the Central Bank, i.e. 4.5% +/- 2% although there are fears that inflation is set to roar ahead in Brazil. That would force the bank to raise the Selic rate from 10.75% where it has been since 21st July. …”
This past Wednesday, January 19th, the Brazilian Central Bank announced that it had increased the Selic Rate by 5 basis points or ½% to 11.25%. The move had been anticipated since July 2010 and yet there had been a degree of though that the move might have been delayed whilst the economic impact caused by the severe flooding was evaluated.
The result is that the Brazilian currency, the Real will rise even more against the US Dollar and the Euro. It has hardly surprising that the Real will become the poster child of the hot money flow in the FX market, after all it does offer a yield return that is over 10 times what can be found on quality Euro Zone debt. That margin means that any punitive levy imposed so far on foreign holdings of Real assets has minimal impact as a disincentive. This will force Brazil’s main exports, coffee, orange juice and of course iron ore to rise in cost value on the world stage. Global commodities have returned to their nominal peak level, last seen in July 2008 and as such, Brazilian companies may well miss out on vital export sales.
The rise rates has blindsided the new President, Dilma Rousseff, who only took office on January 1st. Ms Rousseff has indicated that she wants the real rate down to 2% in 2014. The current nominal rate was 10.75% and adjusted for inflation, before this week’s increase the current real rate is 5.3%.
Brazilian fixed income debt may be attractive in raw yield terms, and yet the specter of more rate rises is a worry. However, what I puzzle over is the impact on the BOVESPA of the reduced export competitiveness of the currency? Today, January 21st, the index slipped 428.44 points or 0.62% to close at 69,133. This has backed away from the level of 70,356 that Ms Rousseff inherited. One could argue that this is just natural rotation in the corrective channel that has been in place since early November 2010. I would tend to agree as whilst above 67, 340 the BOVSPA is still in good shape. What would be a genuine concern would be if 65,593 is lost…that opens a bigger risk to 63, 847.
MarketMind senses that the Brazilian Central Bank will not hesitate to strike out with higher rates again if it is felt that CPI is still galloping ahead. That is not the best solution though. What is needed is a trimming back of the state. Too much government expenditure has catalyzed the impact of crowding out. The trouble is that Ms Rousseff hails from the left of a leftish party and elections are won on the back of wide ranging promises. Now the election is over, there are many electoral IOU’s falling due. One thing is for sure, as the Real rises, so watch for the Brazilians to return to their charge of “currency wars” once again.

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