Brazil's central bank has signaled further aggressive rate cuts after it slashed interest rates by a full percentage point on Wednesday, as Latin America's biggest economy looks to recover from its worst recession on record.
Brazil's benchmark Selic rate was cut by 100 basis points to 11.25%, its lowest level in nearly two years. The central bank's nine-member monetary policy committee also suggested it would keep up the current pace of cuts for now.
For its April issue, Citywire Americas took a look at Brazil's monetary policy moves after it cut its rates for the fourth time in a row in March. Read below to see whether investment experts consider these cuts as sustainable and if we could soon see interest rates converge in Latin America.
Almost eight months on from former president Dilma Rousseff’s impeachment, dark clouds still linger over Brazil’s political future. President Michel Temer’s already low approval ratings are on a downward spiral as
Brazilians protest against potential fiscal reforms and corporate corruption scandals implicating its politicians.
However, there’s hope that the electorate’s mood might improve as Brazil’s beleaguered economy begins to recover. The country’s inflation rate eased more than expected in February, hitting 4.75%, its lowest level since 2010, and the Brazilian Central Bank reacted by cutting the benchmark interest rate by 75 basis points to 12.25%.
Its fourth cut in a row has brought interest rates down from a high 14.25%.
Temer has an official inflation goal of 4.5% this year, but economists expect it to drop below that level.
Olga Yangol, manager of the HSBC Brazil Bond fund, said the government’s reforms to social security this year will provide a vital sign on whether the country’s long-term debt levels are sustainable.
‘If you look at what it’s trying to achieve, it’s not about the immediate benefits this year or next year but more about the longer term given that government spending on social security accounts for 50% of overall expenditure. If this is not curtailed, cuts will have to come from other areas that could damage the economy more.’
Yangol is watching out for attempts to dilute the reforms, such as lowering the retirement age, and how quickly they are introduced, adding: ‘I’m quite confident some sort of reform will be approved, but if it’s ineffective then it’s as good as nothing.’
In the shorter term, Brazil’s goal of continuing to cut interest rates could also be derailed by weather- or commodities-related supply shocks.
Fiscal reforms are not just crucial for Brazil and its weakened economy, but also for the broader Latin American region.
Luis Yance, CIO of Compass Group, recently said during a panel organized by his group in Mexico City in March that many Latin American countries are making considerable progress to wean themselves off their dependency on commodities through fiscal reforms.
However, commodity prices still hold considerable sway over their economies.
‘Going forward, to get the recovery that Latin America will start experiencing this year you may not need commodities to go much higher, but what you do need is for them not to collapse again.
‘But we’re finally seeing inflation going down. When’s the last time we thought Brazil could have inflation at around the 4% or 5% range?’
The cutting club
Brazil and Argentina’s central banks were the first in Latin America to trigger an interest rate cutting cycle back in October and November, respectively, with Chile and Colombia having since followed suit.
Peru and Mexico have not joined the rate cut clique, with the latter opting to raise rates to defend the falling Mexican peso and keep pace with the US Federal Reserve.
‘Expectations are for the cycle of lowering interest rates in the region to extend throughout 2017,’ said Tiago Rego, a London-based fixed income manager for Santander Asset Management. ‘This should result in higher confidence to the consumers and industrial sectors.
‘Lower interest rates create cheaper borrowing costs that will help to increase corporate investments. On the consumer side they will decrease the cost of mortgage payments and reduce incentives to save, thus increasing consumption.’
Like in Brazil, this interest rate cutting cycle is only possible in a context of lower inflation and the expectation is that it will continue to decrease with the help of stable, stronger currencies against the US dollar, he added.
‘This has allowed Latin American central banks to cut rates while the Fed is in a hiking cycle.’
Interest rate convergence
While it might be too early for investors to start worrying about rates in Latin America losing their appeal, fund management groups are preparing for this eventuality.
Historically, international asset managers have a difficult time penetrating Latin America because local investors are used to high returns from local funds.
‘Over time, long-term trend interest rate convergence is a very good story for international fund managers,’ said Sasha Evers, head of Iberia and Latin American for BNY Mellon Asset Management.
‘With interest rates coming down in a lot of countries that’s a kind of tailwind eventually. Clearly, as interest rates converge – though they’re not going to completely converge like developed market rates – that makes diversifying out of domestic markets more attractive. That is a trend that I think over time will lead to more international investment.’
This article was originally published in the April issue of Citywire Americas. To sign up to receive our free magazine, follow this link.