Meus comentários à ata de março (em inglês)

A (modest) quantum of solace

The Brazilian Central Bank (BCB) has just released the minutes relative to its March meeting, in which the Monetary Policy Committee (Copom) decided, by 5 votes to 2, to step up the pace of monetary easing to 75 bps (the minority voted for a 50 bps cut), bringing the Selic rate to 9.75% per annum, reaching the much cherished[1] single digit levels. This particular issue of the minutes has been eagerly awaited, since it would (at least according to the last true believers in the survival of the inflation targeting regime in Brazil) bring the justification for an acceleration of rate cutting pace.

Alas, for the Latter Day believers, the minutes brought very little comfort, as the case for more aggressive cuts relies on even more shaky ground than I believed possible, and note that I had been anticipating a rather swampy soil regarding anything that comes out from Copom these days.

Indeed, whereas BCB’s 2012 inflation forecasts would suggest (rather optimistically) a figure “around the target” in a scenario that embedded rates reaching 9.5% at the end of the easing cycle, 2013 forecasts remained above target, even if the Selic rate would remain unchanged at 10.5%.

It is true that, against all available evidence, the Committee still expects that the current deterioration of the international scenario would have an effect on the Brazilian economy equivalent to one quarter of the observed during the 2008/09 crisis. Yet, this was also true in the preceding meetings and could not be the reason for the acceleration.

Actually, much to my surprise (and remember my expectations about the swampy soil upon which Copom has built its case), the Committee itself believes that “there are no substantive changes regarding the total adjustment of underlying monetary conditions”, meaning that – departing from Central Bank lingo and returning, albeit briefly, to simple mortals language – Copom has apparently not changed its expected budget of total monetary easing.

Moreover, while in the previous minutes the Copom had signaled the Selic rate at single digits, this time it moved one step further, stating that “the Copom assigns a high probability of a scenario that sees the Selic rate moving to levels slightly above the historical minimum [i.e., 8.75% per annum] and there remaining”. In short, the new Selic target is probably 9% per annum.

Hence, the faster easing pace should not, at least according to the minutes, be taken as a sign that BCB sees more room to cut rates relative to what it believed possible in its previous meetings. Instead, it should be seen as a “temporal redistribution of the total adjustment of monetary conditions” (sorry to include such tortuous phrase in my text, but I am trying to be literal here), or, more simply, as a frontloading of the easing process, accelerating now and, presumably, decelerating later.

That said, we could still find no reason for the frontloading, except that “economic deceleration in the second half of the year was stronger than expected”, which, as a justification, falls considerably short of anything that I could imagine until (much to my regret) being exposed to these minutes.

For once, if BCB were to believe its own assumptions, it would have expected the equivalent of one quarter of the 2008/09 international crisis (right?), during which Brazilian GDP fell little less than 5.5%, whereas in the second half of the year it rose very modestly (0.3% in 4Q2011 relative to 2Q2011). If anything, it seems that GDP growth has been actually higher than BCB expectations at the time.

That said, even if it were true that GDP growth had been lower than expectations, at least in this particular Universe, no one has managed to change the past (but there is a chance that neutrinos may travel faster than light, so who knows?), even more when there is plenty of evidence suggesting that interest rates affect domestic demand after a two-quarter lag.

Finally, if one signals frontloading, but maintains that the Selic rate would reach probably 9% at the end of the process, rather than a lower value, currently embedded in yield curve, it would limit the impact on the 1-year rate. It escapes me why a Central Bank would signal more monetary impulse in a week to remove it in the next, but then I may be simply too conservative to understand the innovative reasoning of such move.

In short, if acceleration were a sign that the total budget for rate cuts was higher, then the decision would be logical. Still wrong, to be sure, given the inflation outlook, but, at least, internally consistent. Yet, against a background of an unchanged budget (according to the Committee itself), it manages to be more than simply wrong; it is inconsistent with BCB beliefs as well.

True, at some point the Committee attempts to frame the decision as a forward looking measure, noting that (paragraph 23) that forecasts for growth in Brazil have receded both in 2012 and 2013, but, again, this remains at odds with the evidence. According to the Focus survey, actually conducted by BCB, GDP growth expectations for 2012 have improved modestly between January and March (from 3.23% to 3.28%), whereas expectations for 2013 have barely budged (from 4.25% to 4.24% at the eve of the meeting).

In short, if the reader felt frustrated with the (lack of) explanations for the faster pace at this point, she (or he) may take solace in knowing that she (or he) is not alone. Indeed, there is none.

In terms of the market implications (and this is where I move into shaky ground), my take is that the mention of an unchanged budget of rate cuts should lead to reassessment of the short end of the yield curve, pushing short term rates modestly up, hence some flattening of the yield curve. At the same time, I would not expect – in light of the poor principles that have guided Copom decisions lately – any positive reevaluation of inflation expectations, quite the opposite.

I would truly love to see BCB getting out of the swamp in which it stuck itself, but would not hold my breath waiting for that.

Firm ground (no!)

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[1] “(…) and the people did feast upon the lambs and sloths and carp and anchovies and orangutans and breakfast cereals (…)” Book of Armaments, Chapter 2, 9-21. http://www.youtube.com/watch?v=xOrgLj9lOwk.

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