Central Bank’s Dovish Tilt Will Weigh on Brazilian Assets

Brazilian central bank President Tombini said it will take into account the IMF’s revised forecasts for a deeper recession when it meets this week to decide on policy. Sorry, but we don’t buy it. No central bank should ever be affected by IMF forecasts. Yes, the IMF has great economists and often has excellent advice for its member countries. But no policymaker worth their salt should base their decisions on updated IMF forecasts. We’d add that the central bank usually refrains from making comments about monetary policy on the eve of policy meetings.

The IMF cut its 2016 forecast to -3.5% and its 2017 forecast to flat. We cannot deny that these are significant revisions. Previously, the IMF saw Brazil contracting -1% this year and growing +2.3% in 2017. Yet the IMF forecasts merely bring it more into line with market consensus, and do not really contain any “new news.”

The official statement from the central bank: “Central bank President Alexandre Tombini considers as significant the revisions of growth projections for Brazil in 2016 and 2017 carried out by the International Monetary Fund. President Tombini highlights that all relevant economic information available up to the Monetary Policy Committee meeting is considered in the decisions of the board.”

What does all this really mean? The markets are taking it as a clear signal that the central bank won’t be as hawkish as expected. Consensus was for a 50 bp hike this week to 14.75%, but swap rates have fallen sharply today in favor of a 25 bp hike. Indeed, the entire swaps curve shifted down in response to the dovish comments. By reversing its hawkish bias and using the IMF forecasts as a cover to shift more dovish, the mixed signals from the central bank will likely keep investor’s very negative on Brazil.

Earlier today, Brazil reported the second preview for January IGP-M wholesale inflation at +0.83% m/m vs. +0.69% expected. If this is sustained for the entire month, the y/y rate would accelerate to 10.6% from 10.5% in December. Brazil then reports mid-January IPCA inflation Friday, and is expected to rise 10.74% y/y vs. 10.71% in mid-December. With inflation measures still accelerating, it is not a time to be more dovish. We do not think that a 25 bp hike will help sentiment at all, nor do we think that a hike will be “one and done.” Another hike seems likely at the March 2 meeting, but the magnitude of the tightening is now more unknown given the central bank’s comments today.

Not surprisingly, Brazilian assets are underperforming today. The yield on its 10-year local currency government bonds is up nearly 20 bp to a whopping 16.40%. BRL is the worst performer in EM, down 0.5% on a day when the rest of EM is rallying. The Bovespa is up nearly 1% today, but is clearly lagging the wider MSCI EM (up 1.6%). Markets rightly suspect that the government is leaning on the central bank to be more dovish, and that is simply not a good development in the current investment environment.