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MNI BCB Preview - October 2021: Altering The Flight Path

The perceived decline in fiscal credibility, alongside the persistent deterioration of inflation expectations has significantly increased the likelihood of more aggressive policy tightening from the Copom on Wednesday. Surveys now show a 150 basis point hike as the most likely outcome with several analysts adjusting their forecasts in recent days.

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Executive Summary:

  • Recent events in Brazil have prompted a sharp adjustment in market pricing as well as a wider range of Selic rate predictions for the Copom's October meeting.
  • The perceived decline in fiscal credibility, alongside the persistent deterioration of inflation expectations has significantly increased the likelihood of more aggressive policy tightening.
  • Surveys now show a 150 basis point hike as the most likely outcome with several analysts adjusting their forecasts upwards in recent days.
  • Given the reaction function of the BCB seen earlier this year, even more aggressive action should not be ruled out in an attempt to anchor expectations.

Click to view the full preview: MNI Brazil Central Bank Preview - October 2021.pdf

Fiscal Credibility and Local Assets In Freefall

Local asset prices have been significantly affected by the recent fiscal announcements. The funding of the new 'Auxilio Brasil' program and the ongoing negotiations on precatorios have prompted the government to adjust the crucial spending limit, heavily impacting the government's credibility. Furthermore, multiple departures from the economy ministry team have not only been alarming but has exacerbated the decline of financial assets.

Brazilian equities have extended their downtrend in recent weeks with the news prompting fresh 2021 lows for the IBovespa Index. The DI curve has aggressively shifted higher with swap rate contracts expiring in January 2023 rising close to 225 basis points since the September meeting as shown below. USDBRL has risen roughly 5% from around 5.28 to 5.55 as of publication, after reaching 5.75 on Friday levels coinciding with the April '21 highs for the pair.

Late last week, Economy Minister Guedes attempted to calm markets by reiterating the nation's fiscal fundamentals remain solid and that the government are just slowing down the pace of fiscal adjustment. Additionally, Guedes went on to state the central bank should not risk falling behind the curve in relation to rising inflation. This potentially adds pressure to the Copom to act in line with market pricing and avoid further financial market volatility amid rising fiscal and policy risk premia. Especially considering the most recent survey of expectations point to them already being behind the curve.

MNI/Bloomberg