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The Brazilian central bank should again leave its key interest rate unchanged today. Inflation climbed to 4.6% in March. The increase is likely to have continued in April. In our opinion, this speaks against a rate cut today or in the coming months, about which has been speculated in the market for some time now due to the weak economy. However, the recent inflation development does not offer any reason for an interest rate hike either at present, as the stronger rise in prices is likely to be a temporary phenomenon.
In addition, the core inflation rate of 3.8% remained comfortably below the central bank's target of 4.25%. Also with regard to the pension reform, a neutral stance by the central bank seems justified. The process is rather sluggish, but still, the market remains optimistic and expects the reform to be successfully approved in the second half of the year. The success or failure of the pension reform could have a significant impact on the development of the BRL and thus also on inflation. In the medium to long term, too, the central bank attaches great importance to successful pension reform and general fiscal policy reforms for sustained low inflation.
Therefore, since the (reform) process has only just begun and uncertainty is high, the central bank is likely to maintain its wait-and-see stance and leave monetary policy unchanged for the time being.
We maintain OW and positioned in 3m 1x2 BRL calls 3.95/3.80. Cheap valuations and favorable positioning suggest BRL upside. Our short-term valuation models of the BRL explained by 2-year interest rate differentials, soft commodity prices, 10-year US treasuries and oil prices are showing the BRL as 3.1% cheap, with a fair value at 3.81 vs. the current level of 3.93. Although valuations are not screaming cheapness from a standardized residuals standpoint, it should keep the carry well supported.
Additionally, BRL positions have scope to increase as international investors long USD positions are currently USD 30 billion, according to the latest BM&F data. The BCB has maintained and rolled the USD 69 billions of FX swaps but we believe that the BCB is more likely to act by increasing its bulk of FX swaps in the near term if BRL underperforms. Regarding the next steps for the social security reform (SSR), we continue to wait for the voting outcome from the current social committee phase. We remain OW BRL and local rates in the Model Portfolio and recently opened 3m 1x2 BRL calls 3.95/3.80. Courtesy: JPM & Commerzbank
Currency Strength Index: FxWirePro's hourly USD spot index is inching towards 6 levels (which is neutral) while articulating (at 14:20 GMT).
For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex
