Analysis: Where do we stand after this COPOM meeting in Brazil?

RIO DE JANEIRO, BRAZIL – The Brazilian Central Bank’s decision disclosed after yesterday’s market closed is likely to be a factor in today’s trading – there are some important developments for stocks, the exchange rate and the yield curve.

After experiencing a positive day on Wednesday, May 5th, European stocks had a rough morning this Thursday, May 6th, as investors await the latest U.S. jobs data as well as a decision from the Bank of England.

If higher than expected inflation, not exactly in a process of overheating, remains one of the main risks for stock markets in the short term, then today and tomorrow’s, May 7th, payroll data should be a good indicator of how significant that risk is becoming.

Soon: from 3.50% to 4.25%

As expected, the Monetary Policy Committee raised the basic interest rate for the national economy by 75 basis points, taking the SELIC to 3.50% per year.

As if this were not enough, the monetary authority, in its announcement (the part of yesterday’s event that really mattered), pointed to another similar increase in the next meeting, which would raise the SELIC to 4.25% in June.

However, the announcement was cautious, since, despite signaling yet another increase (“hawkish” or contractionary tone), it also guaranteed that “COPOM’s basic scenario suggests that a partial normalization of the interest rate is appropriate, with the maintenance of some monetary stimulus throughout the process of economic recovery;” in other words, that the interest rate, even if it rises, will remain below the neutral interest rate.

Therefore, the move can be seen as cautious, seeking to please everyone.

The notion is that there is a normalization of the rate, in reaction to rising inflation, but that it will still remain at encouraging levels, below the neutral interest rate (that rate that neither accelerates nor contains inflation, being purely “neutral”) – there is discussion about what this level would be in Brazil today, but estimates point to something between 5.50% and 6.50%, depending on the model used.

It makes sense, since there is an inflationary rebound and exchange rate pressure that could justify a marginal rise in interest rates in the short term, while at the same time Brazilian economic and fiscal conditions would not react very well to an interest rate above neutral.

Throughout the day, the market should better digest the impact of this COPOM meeting, incorporating these understandings into its projections.

There will be multiple interpretations, from a Central Bank that remains permissive on inflation, to one that has lost sensitivity in its communication.

If the first is true, Brazil runs the risk of monetizing its debt, while the increase to 4.25% before the end of the first semester may calm the exchange rate partially, since the fiscal and country risk still render lower levels of the dollar against the real unfeasible. If there is inflation, it could be good for stocks, as real assets grow nominally at the end of the day.

And the yield curve is set for a robust adjustment today. There is still plenty to be incorporated into prices.

Technology under pressure and Yellen’s words still being digested

Technology is in the headlines for all the wrong reasons, with President Biden proposing higher corporate taxes in the U.S. amid a broader debate over accounting for intangible assets and China imposing a record US$2.75 billion fine on Alibaba.

According to leading market experts, taxes on technology should reduce earnings by a mid- to high single-digit percentage (i.e. between 5% and 9%).

China, on the other hand, is unlikely to override regulation amid technology competition from the United States – the Asian giant has entered into disputes with other countries as well. In this case, it is still perceived that the long-term prospects for the tech sector remain attractive.

However, since Yellen’s pronouncement, the U.S. has again experienced the famous sector rotation, with money flowing out of the tech sector into value and reopening theses (the Dow Jones hit record highs at its close yesterday, while the Nasdaq fell).

Note that Yellen’s content was hardly revolutionary. The U.S. economy is on track to fully recover from the pandemic this year as demand recovers and the employment situation improves.

As the economy strengthens, the Federal Reserve will eventually have to raise interest rates, which can’t remain low indefinitely. But investors remain wary about when, exactly, this will happen. Most Federal Reserve members think that the Central Bank will not abandon low interest rates until 2023.

Concurrently, there are growing signs of price pressures in different parts of the economy. Bottlenecks in supply chains and rising commodity prices are factors that add even more fuel to the fire. Whether investors like it or not, post-Covid inflation is here. What matters is whether the higher prices are transitory, as Yellen and Powell predict, or end up having staying power (overheating).

More geopolitical tensions

After some time, geopolitics has again influenced the markets. After the European Union effectively rescinded its investment agreement with China, it seems that it is Australia’s turn to collide with the Chinese.

China has formally suspended economic dialogue with Australia, an important ally in the Pacific for the supply of commodities.

While not extremely relevant, the symbolism is important. The pandemic seems to have disrupted the complex global supply chains, undermining the process of open globalization that we were experiencing.

Thus, political tensions between countries are back on the radar, becoming important factors in the short term, particularly in a market as sensitive as the current one.

Today the Bank of England (BoE) and the Central Bank of Turkey will announce monetary policy decisions in the morning, with an impact on the Pound Sterling and the Turkish Lira, with developments for the European market.

The Bank of England’s rate decision is not expected to change what has been seen in the world’s large Central Banks, with the maintenance of the expansionist discourse from the monetary policy standpoint.

However, there are expectations that the BoE may announce a reduction in bond purchases next month, as some authorities have begun to do around the world.

Still in Europe, it is important to check the impact of retail sales on the market (they came in higher than expected).

In the U.S., several Fed analysts will have another chance to say today that inflation does not threaten low interest rates, undoing the damage that Yellen’s words (evidently true) have caused.

For this Thursday, unemployment claims are important, a day before payroll data. The unit labor cost in the United States and the productivity numbers are also important, even if derived from the first quarter GDP.

In Brazil, the results season remains heated, with releases before the opening and after the closing.

The Treasury holds its public bond auction with the SELIC at 3.50%, while the market follows the Employment Leading Indicator and the Coincident Unemployment Indicator. The Covid CPI follows its schedule, with the president of the Brazilian Health Regulatory Agency (ANVISA) in attendance today.

What does this change in my life?

The United States wants to vaccinate anyone who moves. The country is approaching the milestone of 300 million people vaccinated and, to this end, the FDA is preparing to authorize the use of the Pfizer-BioNTech coronavirus vaccine in teenagers aged 12 to 15, opening the vaccination campaign to millions more.

Pfizer is currently authorized for ages 16 and older, while Moderna is authorized for ages 18 and older – Moderna also expects results soon from its own clinical trial involving adolescents aged 12 to 17, followed by results for children aged 6 months to 12 years later this year.

The expansion would be a big step in the country’s vaccination campaign, but will likely divide the scientific community between those who want to expand the level of immunity and those who are skeptical of the long-term side effects.

Another factor is that the world lacks vaccines, and some question using America’s large stock of immunizers on a group of people who don’t usually present the most severe cases of the disease, while India, for example, is collapsing on hundreds of thousands of cases a day.

Either way, the advance suggests that we are moving closer and closer to worldwide normalization.

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