Brazil’s currency weakened the most since November and short-term swap rates fell sharply after the nation’s central bank kicked off one of the world’s first easing cycles with a bigger-than-expected interest-rate cut.
Swap-rate contracts maturing in January 2024 slumped while the real closed 2.1% lower, the worst performing major currency in the world Thursday. The benchmark Ibovespa equity index also ended the day with losses after earlier climbing as much as 1.5% in Sao Paulo Thursday, joining a global rout in riskier assets.
Policymakers led by Roberto Campos Neto lowered Brazil’s key interest rate by 50 basis points to 13.25% Wednesday night, the first reduction in three years, and signaled more cuts of the same magnitude ahead. Most economists expected a 25 basis point cut, an outcome for which four of the nine central bank board members voted for.
The more aggressive move indicates “comfort with the economic landscape,” said Malcolm Dorson, a senior portfolio manager at Global X. “The central bank is seeing its efforts pay off.”
Campos Neto’s aggressive rate-hike campaign, kicked off in March 2021 when most major economies were nowhere near raising rates, successfully tamed inflation, which is now below the current 3.25% target. In a statement accompanying the decision, policymakers wrote that the consumer price outlook has improved and that longer-term inflation expectations have fallen.
What Bloomberg Economics Says
As we expected, the decision wasn’t unanimous and policymakers crafted language to curb bets on larger cuts at future meetings. We’ve revised our year-end rate forecast down slightly to 11.75%.
— Adriana Dupita, Brazil economist
— Click here for full report
The dovish surprise weighed on the Brazilian real, which trailed only the Colombian peso on a broadly negative day for riskier assets. Latin American currencies are among those that have benefited from carry trades, one of the most lucrative trading strategies of the year that’s seeing its appeal fade as central banks begin to pivot to easing cycles.
The Mexican peso, another favorite of carry traders, slumped 1.8% Thursday.
While officials telegraphed they’ll continue to ease with 50 basis points reductions, swap rates contracts maturing in 2024 and 2025 slumped as traders see increased odds the central bank will have to cut the Selic benchmark rate faster ahead. Markets price in 450 basis points in interest rate reductions in this cycle.
“We expect the BCB to accelerate the pace of easing, and eventually move Selic well below the currently priced terminal rate,” Citigroup strategists including Dirk Willer wrote in a note, adding they’re overweight Brazil rates and long NTN-F local notes due 2027.
--With assistance from Giovanna Bellotti Azevedo.
(Updates with size and scope starting in headline)
Author: Vinícius Andrade and Felipe Saturnino