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UBS Raise Terminal Selic Rate, Maintain Long BRLCOP Recommendation

BRAZIL
  • They raise terminal rate to 9.25%, keep 8.25% for 2021; extra 100bps in 2022
  • With the surprise in the model forecast, setting the SELIC at 8.25% in December 2021 and 8.5% in February 2022 is not enough to converge IPCA with the target next year. In UBS' models, the 0.2ppt above-target forecast suggests an extra 0.75% or so will be necessary on top of 8.50%.
  • UBS are therefore pencilling in one extra hike of 100 bps on 2 February 2022, setting the SELIC at 9.25%. They believe the COPOM will then pause until at least the October 2022 elections.
  • Sentiment towards the BRL weakened amid the political and fiscal tensions seen in August, but foreigners have not increased their BRL shorts in the local market, and the rise in the BRL shorts by locals seems to have peaked.
  • The BRL should benefit from its better carry profile vs most EM peers, and risks are for markets to price in a more hawkish BCB from here. Also, BRL's FX implied vol increased in recent weeks, but it has declined since the BCB started hiking rates, and it could compress as the BCB gets ready to push the Selic rate above neutral starting from the next policy meeting.
  • A more attractive carry-to-vol ratio could also improve sentiment towards the BRL. Finally, with political tensions now arguably easing from its August peak, and with a potential solution to the Precatorios issue now in the horizon, interest towards the BRL could improve. They continue to favour BRL upside versus COP.
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