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Morgan Stanley Expect +25BP, Maintain Preference For Jan 25 DI Receivers

BRAZIL
  • Morgan Stanley economists expect the BCB to deliver a 25bp hike, though market pricing currently implies only a 40% chance of such an increase materialising (10bp priced in). Even if this final hike is delivered, MS would expect a negligible effect on front-end DI rates given the already very elevated level of the (potential) terminal rate.
  • However, market participants will be focused on the BCB's inflation projections, as well as any guidance as to the near-term path of rates (i.e., potential mentions of "higher for longer") to gauge the outlook for the subsequent easing cycle.
  • MS maintain a preference for Jan 25 DI receivers, given the improving inflation outlook in Brazil, though they acknowledge that near-term risk appetite (impacted by the sell-off in core rates) remains an important factor to watch. With ~350bp of easing priced in so far, we prefer to stay away from the very front end (e.g., Jan 24s), as ultimately CPI stickiness risks might delay the start of the upcoming easing cycle (currently forecast for mid-2023 by MS) and as uncertainty still lingers about the pace and timing of cuts.
  • Of course, some of the recent favourable CPI developments in Brazil have already started to translate into lower inflation risk premia (currently ~270bp). However, MS note that current levels remain significantly above average levels (~150bp), suggesting further room for the markets to continue pricing out concerns about the trajectory of Brazil's CPI.
  • Beyond potential CPI stickiness and global risk appetite, MS acknowledge that the upcoming election remains the most significant risk for bullish rates positions, though they note that their analysis suggests that concern around potential fiscal changes has been diminishing, especially in relation to the trajectory of CPI expectations.
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