Brazil’s currency war
The Brazilian Central Bank is currently in an all-out currency war, attempting to control the value of the Brazilian real. While calling the policy misguided may be harsh, the reason I go so far is that it seems the rates hikes are assuming a much higher GDP growth than the one actually possible in Brazil (EWZ).
The Central Bank has lowered its expected 2013 GDP growth to 2.5% from the previous 2.7%. That value still seems too optimistic, as some analysts are forecasting growth even below 2%. This implies contraction in Q4, which wouldn’t bode well for the market.
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The Central Bank highlighted that the acceleration in growth during Q2 was driven by investment and exports, which helps diversify away from private consumption. However, the business confidence slowdown may hurt investment—both domestic and foreign. Plus, the continued threat of tapering by the US Fed may affect investment inflows.
Many producers depend on raw materials from abroad or on commodities priced in US dollars. So a weaker BRL increases the cost base and hinders exporters’ ability to price appropriately in order to compete in the international markets.
Losing momentum with outdated policy
The current monetary policy assumes the economy maintains its momentum so that growth can continue even if rates increase. It’s clear that the Central Bank at this moment has no intention to further ease or stimulate the economy or to continue fighting inflation with interest rate hikes.
The problem is that the outlook painted by the Central Bank is too optimistic for the hawkish stance taken. The Brazilian market (EWZ) is likely to react negatively to further rates hikes.