Yesterday the Banco Central do Brasil reduced Brazil’s benchmark Selic interest rate for the first time in four years. The cut, 25 basis points to 14%, was less than the 50 basis points the market was hoping for. But the dream is that it will be just the first of many reductions in the benchmark rate. The last time the Selic rate was reduced was in October 2012 when the bank cut the interest rate to 7.25%. There’s obviously a lot of room for cuts here–if Brazil’s economy will cooperate. And this first move is indeed a big deal for Brazil’s economy and financial markets.
So why has the response been so relatively modest? The iShares MSCI Brazil Capped ETF (EWZ) is up just 1.42% today. The ADRs of Itau Unibanco (ITUB), the country’s largest private bank and a member of my Jubak Picks portfolio, closed up 1.24% in New York.
Disappointment that the cut was just 25 basis points instead of 50 had something to do with the market response. The central bank’s survey of 200 financial institutions says the market is expecting the Selic to end 2016 at 13.50% And then fall to 11% by the end of 2017. However, that depends on continued progress on reducing inflation.
But part of the reason gains were so modest had to do with a reminder that Brazil’s political crisis is still in full swing–and that more politicians are expected to be hauled into court.
Yesterday, October 19, former Speaker of the House, Eduardo Cunha, was arrested on charges that he was involved in taking 5 million reais in bribes as part of the country’s Lava Jato (Carwash) scandal. Cunha played a central role in pushing forward the impeachment of former President Dilma Rousseff in Congress.
The arrest has set off a wave of extreme worry among the country’s politicians. Cunha is “a living archive,” one congressmen said on Wednesday, and he knows where all the bodies are buried and who has an offshore account. If he were to start talking, more heads would roll, including it is widely speculated, members of the current government led by Michel Timer that took over after Dilma’s impeachment.
Which is why recent charges against Cunha’s wife are so potentially important. Brazilian politicians who stubbornly tell prosecutors they have nothing to say, as Cunha has maintained, have a tradition of changing their tune when prosecutors threaten to file an indictment against a family member.
Another wave of arrests, resignations, and the potential fall of the Temer government would certainly act to put a damper on Brazil’s financial markets and economy. I think interest rates in Brazil have turned a corner and that lower rates will push up the prices of Brazilian assets in 2017. But, because of continued political turmoil, I think you’ve got a chance to wait on the sidelines for a while yet.
The New York traded ADRs of Itau Unibanco, for example, closed at $11.55 today, barely above the 50-day moving average of $11.27 and still below the local high of $12.38 set on October 17.
