Perceive how the rate of interest enhance within the US impacts the Brazilian economic system
- September 23, 2022
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Fed raises interest rates by 0.75 pp and this has an impact on the Brazilian economy. understand in what way
The Federal Reserve decided to raise interest rates by 0.75 percentage point – the fifth straight hike of the year. Despite the rise in interest rates taking place in the US, it is reflected in some ways in the Brazilian economy.
The so-called “Super Wednesday” – when the schedules of the Federal Reserve (Fed, the American Central Bank) and the central bank (BC) converge for the announcement of interest on the same day – it will indicate the directions to be taken by the monetary authorities of the two countries in the coming months.
The rise in interest rates in the US inevitably causes a global impact – and, of course, the Brazilian economy is also hit. The fluctuation of exchange rates and the prices of shares traded on the Stock Exchange are affected, as well as the volume of investments.
The effects of high interest rates in the US for investments in Brazil
One of the main effects of the rise in US interest rates is on Brazilian assets, which become less attractive to foreign investors. In practice, the rise in interest rates in the US encourages investment in US Treasury bonds, which are safer and offer a very low risk of losses. The application in emerging economy countries, such as Brazil, is identified as having greater risk due to the instability of these markets. With less capital available, the chance that the shares of companies listed on the Brazilian stock exchange will be traded is even lower.
Roughly speaking, when interest rates rise, bonds issued by the US Treasury – which would normally already be more attractive to investors – become even more advantageous, which generates a greater flow of investment towards them.
“The more the US central bank raises interest rates, the smaller the interest rate differential between Brazil and the US. And this smaller differential ends up being important to determine, for example, the value of the real”, says Gabriel Barros, partner and chief economist at Ryo Asset, in an interview with InfoMoney. “It is starting to become less interesting for foreign investors to invest in Brazil or in other emerging countries”, he explains.
pressure on the real
The exchange rate is also directly affected by the escalation of basic interest rate set by the Fed. The greater volume of investment in the US leads to the appreciation of the dollar against other currencies, especially those of emerging countries. The reasoning is simple: in Brazil, if investors are driven away to other markets, the American currency enters the country in smaller quantities; scarcer, its value over the real rises.
“The real tends to be more pressured by this higher interest rate from the Fed”, says Barros. “Under normal conditions, this is pressure against the appreciation of the real. The higher the Fed interest rate, the less room for the real to appreciate.”
One of the consequences of this movement is the increase in imported products, commodities and high-tech items, among others. At the end of the day, the appreciation of the dollar may even generate an increase in inflation in Brazil, as the importation of components widely used by the national industry becomes more expensive. One of the most emblematic examples is the oil produced by Petrobras, whose price is pegged to the dollar. The fuel price policy is linked to the fluctuation of the value practiced in the international market.
Higher than expected inflation
At the Fed’s June and July 2022 meetings, there was a 0.75 percentage point increase in the interest rate, bringing the indicator to the range of 2.25% to 2.5% per year. The bullish cycle began in March – in 2022 alone, the index had already risen 2.25 points since then.
According to data released on September 13 by the US Department of Labor, the Consumer Price Index (CPI) recorded an increase of 0.1% in August compared to the previous month. In the 12-month period, inflation is 8.3%. The result came above estimates, which pointed to a deflation of 0.1% on a monthly basis and an annual increase of 8.1%, according to Refinitiv. To contain inflationary pressure, the Fed’s monetary tightening must continue.
“What Fed officials have signaled is that they will avoid making a decision based on a single month. From the Fed’s point of view, they are looking more at the forest of economic data than the tree”, analyzes Gabriel Barros.
“With core inflation pressured and the Fed still far from reaching the terminal rate, they should continue [a subida dos juros] regardless of this point result. The Fed’s message is that interest rates are still a long way from what they see as the ideal to tame the situation,” adds Ryo Asset’s chief economist.
Expectations for Selic
In “Super Wednesday”, in addition to the Fed’s decision on interest rates in the US, the Central Bank’s Monetary Policy Committee (Copom) will meet to define the basic interest rate for the Brazilian economy (Selic). Currently, the index is 13.75% per year, but there are those who imagine that the cycle of highs is finally interrupted.
At the Copom meeting in August, the Selic rose 0.5 percentage point. The BC started the interest rate hike in March 2021, when it raised the rate from 2% (historic low) to 2.75% per year. Since then, there have been 12 consecutive increases. Earlier this month, BC President Roberto Campos Neto indicated that inflation still attracts attention in the country and, therefore, interest rates should not begin to fall immediately.
“The market expects the current Selic index to remain unchanged or an increase by another 0.25%, to 14% per year. The BC should hold this rate at a high level, 13.75% or 14%”, projects Gabriel Barros. “The interest rate should stay high for a long time. The BC will only reduce interest rates when it is very confident that it has managed to anchor inflation expectations for 2023 and 2024.”
Recession on the horizon
In addition to raising interest rates to face inflation, the US has been preparing for an increasingly likely economic recession, possibly starting in mid-2023. For Barros, the recession is inevitable, but it should not be too deep. “You still have the strong trade and services sectors in the US. With the labor market resilient, there could be a support for economic activity,” he says. “It is a recession, but it will end up being a mild recession.”
With the imminent contraction of the world’s largest economy, emerging countries like Brazil should prepare for a hostile scenario from next year – just when a new presidential term will begin, on January 1st. “In addition to the US recession, we have China and Europe slowing down. It is a synchronized slowdown of major economies in Brazil’s main trading partners. There’s no way it won’t hit us. It will take the breath away from our growth”, projects Barros.
“So far, the Brazilian economy has been doing well and is surprising, but this has a lot to do with the post-pandemic reopening and the income transfers presented by the Executive and approved in Congress. It won’t last forever. The cyclical recovery will eventually come to an end.”